A federal district court has ruled that the members of an accounting firm were each personally liable for the trust fund portion of the unpaid federal employment taxes of their client.
Buddy Light Accounting & Tax Services provided accounting and payroll services to their client, GC Affordable Dining, Inc., which included managing payroll and accounts payable, making federal tax deposits, issuing payroll checks to employees, and preparation of federal employment tax returns (Form 941) for the client. When the client began experiencing financial difficulties, it failed to make its required federal employment tax deposits. The accountants were aware of the cash flow problems, and the failure of the client to make its required deposits. The accountants advised the clients repeatedly that there was insufficient income to pay creditors, including the IRS. The client nevertheless instructed the accountants to continue to issue payroll checks to employees and to make payments to certain creditors, but did not specify that payments should not go to the IRS. The accountants did not make payroll deposits to the IRS, and the IRS, in a subsequent “trust fund” investigation of the client, assessed the unpaid trust fund taxes not only against the owners of the client business, but also against the two members of the accounting firm personally. When the clients sued in United States District Court challenging their liability, the IRS filed a countersuit against the accountants in the same action seeking judgment that the accountants were personally liable as well.
Under Section 6672 of the Internal Revenue Code, any person responsible to collect, account for and pay over federal employment taxes who willfully fails to do so is liable for a penalty equal to the total amount of tax not paid. Often referred to as the “trust fund recovery penalty”, the “100% penalty”, or simply “trust fund taxes”, personal liability contains two basic elements: (1) the individual must be a “responsible person”, and (2) this person must act “willfully”. In order for an individual to be held liable for the trust fund recovery penalty he must be a “person” responsible for collection and payment of federal employment taxes. A responsible person is any person who is connected or associated with an employer so that he has the power to see that the taxes are paid. Factors to be considered in evaluating whether an individual is a responsible person include whether the person (a) served as an officer or director of the business; (b) controlled the company’s payroll; (c) determined which creditors to pay and when to pay them; (d) participated in the company’s day-to-day management; (e) had the ability to hire and fire employees; and (f) possessed the power to write checks. Willfulness results when a responsible person has knowledge of unpaid taxes but consciously pays the withheld amounts to others, and prefers other creditors over the IRS.
In Erwin v. United States, 111 AFR2d 2013-748 (M.D. N.C., Feb. 5, 2013), the District Court determined that the members of the accounting firm were both responsible persons of the client business, and they acted willfully, thus being personally liable for the unpaid trust fund taxes. While the accountants were not employees, officers or directors of the client business, the District Court determined that the accountants had substantial control over payroll operations, were engaged in day-to-day affairs, had access to bank and financial information, and wrote checks for the client business, all when the accountants knew that the employment taxes were not being paid. The accountants had access to and used a “signature stamp” of the client on checks and possibly other documents for the clients as well.
While personal liability for unpaid federal employment taxes is certainly not a new concept in the law, the Erwin decision represents an example of when individuals, even those not directly employed with or having an ownership interest in a business, can be held personally liable for the trust fund portion of these unpaid taxes. Erwin presents facts where the client’s accountants simply “stepped over the line”, and performed accounting and tax functions normally reserved for owners and key management personnel of a business. When a business is experiencing financial difficulties, and creditors, including the IRS, are not being paid, Erwin is a harsh reminder that even the accountants for the business can be personally liable for unpaid taxes if they become too involved in business affairs.