Magazine article The CPA Journal

Rethinking the 'Responsible Person' Penalty

Magazine article The CPA Journal

Rethinking the 'Responsible Person' Penalty

Article excerpt

One benefit of the corporate form of business is limited personal liability. A corporation may file for bankruptcy and have debts canceled by the court. A discharge in bankruptcy precludes a creditor from pursuing collection from corporate managers or owners. One such debt that regularly arises in a corporation is payroll taxes. Because a company pays only a net check to the employee and the balance to the 1RS, some managers of companies succumb to the temptation to not remit payroll tax liabilities and instead use the money to satisfy obligations they consider more pressing. As all accountants know, however, business prospects often worsen and debts cannot be paid. The company then files for bankruptcy and is reorganized or liquidated. Most debts are discharged, and the company obtains a fresh start.

In 1954, Congress made a major revision to the Internal Revenue Code that enacted IRC section 6672, the 100% penalty for individuals that do not remit payroll taxes. Congress enacted section 6672 to reduce the occurrence of the 1RS being a discharged creditor by encouraging prompt payment of these payroll taxes.

Application of IRC section 6672 requires careful identification of the components of payroll liabilities. The taxes subject to section 6672-federal withholding and the employee FICA and Medicare taxes withheld-are referred to as "trust fund taxes." Trust fund taxes do not include the employer portion of FICA and Medicare or federal unemployment taxes, which are considered a liability of the corporation not subject to section 6672.

Section 6672 provides that any "responsible person" required to collect and remit trust fund taxes shall be liable for a penalty equal to the amount of the tax that was to be withheld and paid to the 1RS (the 100% penalty). The new name for the penalty is "the trust fund recovery penalty." A responsible person can be any officer or employee of a corporation who is responsible for accounting for and paying the taxes to the 1RS.

Responsible and Willful

Two primary tests must be met in order for IRC section 6672 to apply: the responsible person test and the willfulness test. These two tests determine whether a person can be held liable for the taxes due. A responsible person has the primary duty in the corporation to collect and remit taxes on wages. If more than one person fits this definition, all may be held liable under section 6672. The 1RS has broad powers for selecting responsible persons. As a practical matter, it often pursues those with the deepest pockets. In some cases, it pursues those standing nearest the fallen corporation. A responsible person could be someone who computes the payroll, writes payroll checks, signs checks, supervises the payroll function, or has managerial control over the affairs of the corporation. Directors and shareholders can be responsible persons.

The critical factor that makes someone a responsible person is the power to make a decision to pay or not to pay. The courts look broadly over the company to find who had the actual authority to pay the funds and who controlled the process of determining the preference of payment. In many court cases, accountants in management have claimed that they were merely acting on orders from superiors and would have been punished or fired if they had paid the tax to the 1RS. The courts have sided with the 1RS in most cases, because these accountants held additional managerial positions over and above their accounting role, making them already in fact responsible persons.

The willfulness test determines if a person knew the taxes were not paid and willfully and intentionally did not remit the funds to the 1RS after knowing that such funds were due. The courts consider the state of mind of the person at the time of the willful act as a material fact, but each court uses different criteria. A finding of reasonable cause is not sufficient to overturn a finding of willfulness. …

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