The Internal Revenue Code requires employers to withhold social security and federal excise taxes from their employees' wages. [§§ 3402(a), 3102(a).] The employer holds these monies in trust for the United States.§ 7501(a) [here]. Accordingly, courts often refer to the withheld amounts as “trust fund taxes”; these monies exist for the exclusive use of the government, not the employer. Payment of these trust fund taxes is not excused merely because as a matter of sound business judgment, the money was paid to suppliers in order to keep the corporation operating as a going concern – the government cannot be made an unwilling partner in a floundering business.
The Code assures compliance by the employer with its obligation to pay trust fund taxes by imposing personal liability on officers or agents of the employer responsible for the employer's decisions regarding withholding and payment of the taxes. Slodov v. United States, 436 U.S. 238 (1978). To that end, § 6672(a) [here] of the Code provides that “[a]ny person required to collect, truthfully account for, and pay over any tax . . . who willfully fails” to do so shall be personally liable for “a penalty equal to the total amount of the tax evaded, or not . . . paid over.” § 6672(a). Although labeled as a “penalty," § 6672 does not actually punish; rather, it brings to the government only the same amount to which it was entitled by way of the tax.
Personal liability for a corporation's trust fund taxes extends to any person who (1) is "responsible" for collection and payment of those taxes, and (2) "willfully fail[s]" to see that the taxes are paid.In addition to the TFRP which is a civil liability only, Section 7202, here, imposes a parallel criminal penalty for those individuals who are responsible within the employer organization to attend to the withholding, accounting for and paying over.
Failure to withhold, account for and pay over is a common phenomenon with businesses encountering cash flow difficulties. The person or persons within the organization who determine which creditors get paid rob Peter to pay Paul -- i.e., they divert the withheld tax [or deemed withheld] to other creditors (sometimes to themselves). In many, perhaps most of these cases, they intend only a temporary diversion -- hoping to keep the business afloat, steady the ship, and produce cash flow sufficient to pay the trust fund taxes and any penalties for delinquent reporting and payment. Sometimes (many times in the aggregate across the economy) the business goes under and the trust fund taxes are not paid. This sets up the potential for the TFRP and, in some of the more egregious cases, criminal liability under Section 7202.
Tax practitioners deal frequently with clients who are facing IRS action or potential action against them individually for their employer's nonpayment of trust fund penalties. Often clients will say that the potential civil liability for the TFRP is bad enough, but they certainly don't like the risk of criminal prosecution. I have had clients ask me if I can illustrate when conduct crosses the line from civil TFRP liability only into potential criminal prosecution.
That is a very tough thing to do. Technically, every intentional violation of the known legal duty can result in criminal prosecution. That is basically the same standard for the civil liability under § 6672, although being civil in nature, the civil liability can and will be imposed in situations where the criminal liability would not. But the line is very unclear and the differences may be somewhat uncertain because the criminal cases are brought by DOJ Tax for only the most egregious cases. The limited number of cases reflect prosecutorial discretion and the number of cases that can be prosecuted. Stated bluntly, as with tax crimes generally, DOJ Tax cannot prosecute all of the cases it could under § 7202, nor could the criminal justice system process all that could be prosecuted. Generally (that is a fuzz word), only the most egregious are prosecuted.
A DOJ Press Release, here, from yesterday, involving a defendant named Maria Elizabeth Townsend (no relation to me), illustrates:
A Burbank, Washington, woman was convicted by a jury yesterday after a five-day trial in the U.S. District Court in the Eastern District of Washington located in Spokane, Washington, of willfully failing to pay more than approximately $2.6 million in federal payroll taxes withheld from her employees, announced Principal Deputy Assistant Attorney General Caroline D. Ciraolo of the Justice Department’s Tax Division and U.S. Attorney Michael C. Ormsby of the Eastern District of Washington.
“Employers who willfully fail to timely collect, account for and deposit employment taxes are, quite simply, stealing from their employees and the U.S. Treasury,” said Principal Deputy Assistant Attorney General Ciraolo. “Yesterday’s verdict sends a clear message to those individuals who view this obligation as optional – you will be investigated and prosecuted to the fullest extent of the law.”
According to the evidence introduced at trial and other documents filed in the case, Maria Elizabeth Townsend was the president and majority owner of Townsend Controls Inc. (TCI), an electrical contractor in Pasco, Washington. The majority of TCI’s employees were members of Local 112 of the International Brotherhood of Electrical Workers (Local 112). From at least April 1, 2007, through Sept. 30, 2009, Townsend withheld employment taxes from the wages of the members of Local 112 that TCI employed as well as its other non-union employees. She willfully failed, however, to pay those taxes to the Internal Revenue Service (IRS). Instead of paying the withheld taxes, Townsend purchased several automobiles and made large disbursements of corporate funds to her family members.
Townsend faces a statutory maximum sentence of five years in prison and a $250,000 fine for each count of failing to pay over employment taxes. Sentencing is scheduled for June 4.I have highlighted the portion that I want to focus on. Notice that, as the Principal Deputy AAG articulates the criminal exposure, responsible who do not withhold, account for and pay over are at risk of criminal prosecution. I think that is what she has to say, because it is a true statement.
The risk of criminal prosecution has two layers that I am discussing here. Every responsible person who intentionally with knowledge of the obligation to withhold, account for and pay over is at risk of criminal prosecution. Any lawyer should be able to give that advice to a client and should give that advice. The more subtle issue is when is the risk material in any given fact pattern. That is a tougher call for the lawyer. In many fact patterns, the lawyer is only able to say, with appropriate qualifiers, that the risk might be high or low that, if DOJ Tax were aware of all the facts (that hopefully the client has disclosed to the lawyer), it would or would not prosecute the client. In some cases, I feel comfortable advising the client that, in his general fact pattern, I have not seen DOJ Tax prosecute. I quickly caution that that is not advice that DOJ Tax will not prosecute. [In some ways it is like a lawyer fielding a question from a client who wants to know whether he will get a speeding ticket for driving 66 mph in a 65 mph zone; technically, the person has violated the law and could be ticketed; but, in the exercise of discretion most officers will not ticket unless the violation is more egrgious -- say 70 mph or higher; but the lawyer can hardly advise of that and certainly should not be advising that, because of low police resources, he will never be caught anyway.]
Generally, where a client is concerned about this, there is little that can be done about the past. The question is what the person will do today and in the future. The solid advice is to withhold, account for and pay over to the IRS. Failing that, cause the employer to not incur the obligation (fire / lay off employees, get employees to work for no pay (not likely) or close the business) or resign the position with the employer that causes the potential liability. At least the person will not be exacerbating the problem by turning a low risk case into a high risk case.