March 27, 2017

Trust Fund Penalties – Good Intentions Gone Bad

Employers are entrusted to withhold Social Security, Medicare, and income taxes (payroll taxes) on behalf of employees and remit those payroll taxes to the IRS. Economic circumstances may arise which might tempt employers to ‘borrow” on payroll taxes with the intention of paying it back. To insure that employers remit all payroll taxes in a timely manner, Congress put in Internal Revenue Code Section 6672. Section 6672 imposes a penalty equal to the amount of payroll taxes required to be remitted against any person who is a “responsible person” and willfully fails to collect and pay the payroll taxes to the IRS. This penalty is known as the Trust Fund Recovery Penalty (TFRP).

This brings us to a recent decision of the Texas district court which held a doctor liable for $4.3 million in TFRP. Dr. McClendon ran a family practice for a number of years. During this time his CFO was helping himself to the payroll taxes that were supposed to go to the IRS. After discovery of the malfeasance, Dr. McClendon immediately closed his practice and remitted all of his remaining receivables to the IRS. Not wanting to leave his employees without their final paycheck, Dr. McClendon loaned $100,000 to his practice with the restricted purposes to pay his employees.

Because the good doctor decided to loan his company $100,000 and pay his employees ahead of the remaining payroll taxes due, the IRS found Dr. McClendon was both the responsible person and willfully failed to remit and pay remaining payroll taxes of $4.3M.

In court, Dr. McClendon did acknowledge that he met the first criteria of responsible person, but he asserted did not meet the second of willfully failing to pay over taxes. The district court disagreed. The court affirmed that though the doctor’s intentions were honorable in nature, deliberate payment of creditors ahead of the IRS made the doctor’s actions willful.

So, now a $100,000 loan becomes a $4.3M tax liability.

As an employer or person responsible for payroll taxes, if you find that payroll taxes have not been timely remitted, make sure payment is made and if you discover that theft or error has caused payroll taxes to be in arrears and you cannot make full payment, do not pay any other creditors first, not even a dollar.