Criminal Restitution for Employment Taxes and Trust Fund Liability Under Section 6672 (6/18/13)

In Ross v. United States, 949 F. Supp. 2d 272 (D DC 2013), here, the defendant had been convicted of  tax evasion under Section 7201, here, for failure to pay employment taxes of a corporation he owned. (Note that the other principal felony charge that for nonpayment of employment taxes is Section 7202, here, which is a criminal counterpart to a civil liability for the trust fund portion of employment taxes under Section 6672, here; presumably, the defendant could have been charged under that Section 7202, but was instead charged with evading the corporation's liability for trust fund taxes.)

Pursuant to the plea agreement, the court ordered restitution for the corporation's liability for the employment taxes in the amount of "the actual [employment] tax of $203,651.43 and the resulting interest."

At this point, it is helpful to note the components of employment taxes that were the subject of restitution.  Employment taxes consist of:  (i) withholding income tax from the employees' wages and the employee's share of FICA and Medicare tax, also withheld from the employee's wages, referred to as the trust fund portion; and (ii) the employer's share of FICA and Medicare taxes, referred to as the nontrust fund portion.  (In other words, the trust fund portion is the amounts withheld from employee for remission to the IRS for application against the employee's tax liabilities for income tax, FICA and Medicare tax.  The restitution was for the corporation's employment tax without any differentiation between trust fund and nontrust fund portions.

The plea agreement did not provide as to how the restitution payments would be allocated between trust fund and nontrust fund portions.  Therein lay the rub.  (Outside the criminal context, the standard gambit is to insure, if possible, that taxes paid be applied first to the trust fund portion of the tax liability, but neither the plea agreement nor the restitution order addressed that issue.)

The IRS assessed the Section 6672 penalty, referred to as the trust fund recovery penalty ("TFRP"), against the defendant.  As a result, the defendant obviously preferred that the restitution payments be applied first to the trust fund portion because that was the only portion of the corporation's employment tax liability that he was personally liable for.  That was an issue in the case.

The Court held against the defendant, reasoning as follows:

Plaintiff further appears to challenge the IRS's application of the bulk of the restitution payments to Spectrum's outstanding employment taxes, rather than to his 6672 assessments. See Opp. at 14. In so arguing, Ross points to no authority — either in the plea agreement or from anywhere else — that dictates where the IRS must direct restitution payments. Courts have held, on the contrary, that the IRS may direct payments "in the best interest of the United States." Concert Staging Serv., Inc. v. Comm'r, 102 T.C.M. (CCH) 315, No. 3050-09L, 2011 WL 4448911, at *8 (U.S. Tax Ct. Sept. 26, 2011) (internal citation omitted); see also Davis v. United States, 961 F.2d 867, 879 (9th Cir. 1992) ("Involuntary payments, like undesignated payments, may be credited as the IRS desires."); In re Tecson, 291 B.R. 199, 200 (Bankr. M.D. Fla. 2003) ("[I]f the payment is made involuntarily, the payments will be allocated in a manner serving the best interest of the IRS.") (internal quotation marks and citation omitted). 

In Concert Staging, the Tax Court further observed that the IRS's "practice of prioritizing the payment of non-trust-fund taxes is reasonable because, consistent with the purpose of section 6672, it enables the Commissioner to reach those responsible for the corporation's failure to pay the taxes which are owing." 2011 WL 4448911, at *8 (internal quotation marks and citations omitted). Here, the IRS directed most of Ross's restitution payments to non-trust-fund taxes and penalties assessed to Spectrum (as well as interest on both), and the sum recovered did not even fully satisfy that figure. 

The IRS transcripts, furthermore, show the Service was careful not to double count. In other words, when Ross's restitution payments were applied towards Spectrum's employment taxes, any payments directed to the trust-fund portion of Spectrum's liability were subtracted from the balance Ross owed on the 6672 penalties. For example, on August 30, 2010, the IRS applied $37,871.30 of Ross's criminal restitution payments to Spectrum's liability. See Exh. 44. On the same day, the IRS reduced Mr. Ross's 6672 liability for a portion of the $37,871.30 that it attributed to the trust-fund portion. See Exh. 15 (on 8/30/2010, two adjustments — $7,247.04 and $6,970.94 — are credited to Ross's account under code 241 ("Miscellaneous penalty adjustment IRC 6672 Trust Fund Recovery Penalty Balance Due to Payment by Related Business Entity")). Similarly, when Ross made payments towards the 6672 penalties, those amounts were correspondingly removed from Spectrum's outstanding employment taxes. See Exhs. 16, 45 (on June 21, 2010, Peter Ross paid $25,422.05 toward his 6672 liability for Q4 1999 and IRS reduced Spectrum's liability by same amount ("Balance adjusted trust fund recovery cases" for $18,022.35 and $7,399.70)). 

In sum, because the IRS was not required to direct the restitution payments to the trust-fund portion of Spectrum's outstanding employment taxes, Ross did not pay the same taxes twice.

The lesson, of course, is that practitioners need to be careful in structuring such restitution payments, if possible, to apply to the trust fund portion.  I doubt that such an attempt will be successful where the charge is under Section 7201 for the employer's employment taxes in the aggregate (including both trust and nontrust fund portions).  If this is not done in the plea agreement, the IRS will take the position that the restitution payments are not voluntary and therefore that it can apply the payments against the portion of the employment tax that best suits the IRS -- the nontrust fund portion as in the case. (Note that restitution is not permitted when the only counts of conviction are Title 26 offenses, as in this case, except if restitution is provided by plea agreement.)

Practitioners should note that the problem would not have arisen under Section 7202 because the crime there, like the Section 6672 civil penalty, is the willful failure to pay over the trust fund taxes.  Hence, the restitution would have included only trust fund portion and all payments of restitution would have been applied to the trust fund portion.  Perhaps in negotiating a plea, it might be possible to take the plea under Section 7202 rather than 7201.  The Government will really lose nothing in its criminal case by doing so, because the nontrust fund portion will be included in the tax loss because its nonpayment is relevant conduct. And, although this is a nice distinction, readers will recall that Title 26 offenses do not permit mandatory restitution; rather, Title 26 offenses only permit contractual restitution or, perhaps, restitution not as compelled by the offense of conviction but by some other benefit conferred on the defendant in the sentencing.  Since most criminal charges are resolved by plea, the Government will almost certainly demand contractual restitution in the amount of all the tax losses -- including the nontrust fund loss.