Court Holds that the Trust Fund Recovery Penalty is a Tax For Purposes of Tax Evasion, § 7201 (11/10/18)

In United States v. Prelogar, 2018 U.S. Dist. LEXIS 188305 (D. Mo. 2018), here), the Court rejected the defendant's argument to dismiss the following count of tax evasion, § 7201 that defendant:  "did willfully attempt to evade and defeat the payment of the Trust Fund Recovery Penalty ("TFRP") due and owing by him to the United States of America . . . and the payment of income tax due and owing by him to the United States of America."  The first thing to note is that two types of evasion are alleged -- one for the TFRP and the other for income tax.  I focus here on the allegation of tax evasion for the TFRP.

Defendant's argument was simple.  Tax evasion requires a tax to be evaded (or, in the language of the statute attempted to be evaded).  The TFRP, as stated in § 6672, is a "penalty" rather than a tax.  Therefore a person evading the TFRP is not evading tax and thus outside the scope of tax evasion.

The Court rejects the defendant's argument as follows:

Count I charges that Defendant "did willfully attempt to evade and defeat the payment of the Trust Fund Recovery Penalty ("TFRP") due and owing by him to the United States of America . . . and the payment of income tax due and owing by him to the United States of America" in violation of 26 U.S.C. § 7201. Defendant argues that § 7201 does not apply to him because the TFRP owed is a penalty and not a tax. In support of this argument, Defendant quotes Section 7201, which prohibits the willful evasion of "any tax imposed by this title or the payment thereof." Id. (emphasis added). Initially, the Court notes that Defendant's argument does not justify dismissal of Count I because Count I alleges that Defendant attempted to evade the payment of both taxes and penalties. At best, Defendant's argument would justify only limiting the scope of Count I. Regardless, the Court does not agree with Defendant that § 7201 applies only to evasion of the tax itself. Section 7201 makes it unlawful to attempt "to evade or defeat any tax", and § 6671(a) states that "any reference in this title to 'tax' imposed by this title shall be deemed also to refer to the penalties and liabilities provided by this subchapter." 26 U.S.C. § 6671(a). As explained in the Report, a "plain reading of Section 6671(a) leads to the inescapable conclusion that a reference to 'tax imposed' in a statute under the Internal Revenue Code [Title 26] must be deemed to include a 'penalty' provided in the subchapter [Subchapter B: Accessible Penalties]." Therefore, Defendant's arguments with respect to Count I are rejected. 

In Defendant's objections to the Report, he argues that the Fifth Circuit supports his claim that a penalty is not a tax for the purposes of § 7201. (Doc. 68, p. 3.)1 In United States v. Wright, 211 F.3d 233 (5th Cir. 2000), the Fifth Circuit addressed whether petitioners could be prosecuted for tax evasion if they owed only interest and penalties. Wright, 211 F.3d at 236-37. The Court based its analysis by relying on Sansone v. United States, 380 U.S. 343 (1965), where the Supreme Court observed that a conviction under § 7201 requires proof of a "tax deficiency." The Fifth Circuit then relied on the tax code's definition of "tax deficiency" - which does not include a tax penalty — to conclude that a conviction under § 7201 cannot be predicated on the willful evasion of a tax penalty. Id. at 236 & n. 3-4 (citing 26 U.S.C. §§ 6211, 6601(e)). The Court declines to follow Wright for several reasons. First, Wright does not discuss § 6671. Second, the phrase "tax deficiency" does not appear in § 7201, so the more limiting definition of "tax deficiency" (as opposed to the definition of "tax" found in § 6671) is inapplicable. Third, the issue in Sansone involved the circumstances under which a person charged with felony tax evasion is entitled to a lesser-included offense instruction for the misdemeanor of willful failure to pay a tax. Thus, it does not appear that when Sansone said the elements of § 7201 included a "tax deficiency," it meant to use the technical definition of the phrase as found elsewhere in the tax code. For these reasons, the Court denies Defendant's arguments with respect to Count I.

I offer readers the following documents:

• The magistrate's report (Docket Entry 65), here.
• Defendant's objections to the magistrate's report (Docket Entry 68), here.
• The US response to Defendants' objections (Docket Entry 69), here.
• The docket entries as of 11/10/18, here.

JAT Comments:

1.  I think more can be said on the issue of whether a person evading payment of the TFRP evading tax.  It is true that the TFRP is statutorily labeled a penalty.  But, "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."  Turnbull v. United States, 929 F.2d 173, 178 n.6 (5th Cir. 1991).  As it operates, it is simply a mechanism to collect the underlying Trust Fund Tax. On this reasoning, evasion of the TFRP would be evasion of the underlying Trust Fund Tax.

The following is from the current working version of my Federal Tax Procedure Book:

4. IRS Policy to Collect Only Once.
The IRS's policy is to collect only once the underlying trust fund tax that should have been paid over. In this sense, the TFRP might be viewed simply is a collection mechanism for the unpaid underlying trust fund taxes rather than a true penalty imposed to the full extent on each responsible person.  Literally read, § 6672 could impose the delinquent trust fund tax upon the employer and each responsible person so that the IRS could theoretically collect the trust fund tax amount more than once and indeed could pursue the TFRP even if the corporate taxpayer paid the trust fund tax delinquent.  Obviously, to the extent that imposition of civil punishment has a deterrent effect, the imposition of the TFRP on each responsible person would have the maximum deterrent effect.  But, as interpreted, the IRS only collects the trust fund tax delinquency once and can collect from any available source – the employer or the persons subject to the TFRP.  This collection of the tax only once (either from the employer or the responsible persons) means that the TFRP really functions as a collection mechanism rather than a penalty.

2.  As I note in the current working version for my FTP Book:

A question has arisen but not yet resolved as to whether the TFRP is a penalty subject to§ 6751(b)(1)’s requirement that the proposing officer’s immediate superior approve in writing or whether, as a collection mechanism for the underlying trust fund tax, it is not a penalty (though nominated a penalty in the statute).  fn   fn Blackburn v. Commissioner, 150 T.C. ___, No. 9 (2018) (noting the issue but not resolving it); United States v. Rozbruch, 2014 U.S. Dist. LEXIS 91789 (S.D.NY 2014) (holding not a penalty for purposes of § 6751(b) but on appeal, the Second Circuit ducked the issue, United States v. Rozbruch, 621 Fed. Appx. 77, 2015 U.S. App. LEXIS 19223 (2d Cir. 2105)); and CCN 2018-006 (6/6/18) (IRS position is that it is not a penalty subject to § 6751(b)).

3.  For the foregoing reasons, since the TFRP is a collection mechanism for the underlying Trust Fund Tax, the case could easily have been pled as attempt to evade payment of the Trust Fund Tax by evading the TFRP.  That would have easily fallen within § 7201 through semantics.

4.  In Mortenson v. National Union Fire Insurance Co., 240 F.3d 677 (7th Cir. 2001) (a Posner opinion), here, the Court decided the following question:  "whether the statutory penalty imposed on responsible persons for willful nonpayment of payroll taxes is a 'penalty' within the meaning of an exclusion in the D & O policy."  The Court held that it was a penalty for purposes of the D&O policy.  The Court said (cleaned up):

And finally the fact that the IRS uses section 6672(a) as a collection device does not distinguish it from a number of unmistakably criminal penalties, such as those for minor thefts, vandalism, and other minor property crimes, where the police use the threat of prosecution to induce the wrongdoer to make restitution to his victim more often than they actually prosecute. 

We conclude that section 6672(a) imposes the civil counterpart of a fine.   Monetary penalties for wrongful conduct are civil fines, and are encompassed by the “fines or penalties” provision in the insurance policy.   Any other conclusion would inject extreme uncertainty into the interpretation of insurance policies.   Whether a penalty so designated in the statute creating it, a penalty that on its face was a civil fine, was a penalty within the meaning of the policy exclusion would require a searching and often indeterminate inquiry into the history and function and interpretation and details of the statutory scheme. Alerted to this concern by the court's questions at argument, Mortenson's lawyer suggested that the policy could be rewritten to exclude “penalties that are called penalties in the statutes that create them.” That would stop inquiry at the face of the statute. It is a good suggestion, but the possibility of making an insurance policy clearer doesn't imply that it is unclear in its present form. Anyone reading the insurance policy at issue in this case-and remember that a D & O policy is purchased by a firm, not by an individual, and protects business executives, not the average consumer-would think that the term “penalties and fines” covered exactions described as penalties or fines in the statutes imposing them. The reader would not think the exclusion limited to a subset of penalties and fines impossible to identify without a protracted inquiry with an unpredictable outcome. 

 We have yet to mention the most compelling argument against the interpretation for which Mortenson contends. For obvious reasons, insurance companies try to avoid insuring people against risks that having insurance makes far more likely to occur. The temptation that insurance gives the insured to commit the very act insured against is called by students of insurance “moral hazard” and is the reason that fire insurance companies refuse to insure property for more than it is worth-they don't want to tempt the owner to burn it down. Consider the likely effects of insuring against the section 6672(a) penalty. When a firm gets into financial difficulties and creditors are pressing it for repayment, the firm tries-Opelika tried-to pay the most pressing creditors currently and hold off the others till later. This tendency is one of the reasons for the rules against preferences in bankruptcy, preferences being the favoring, often, of the most exigent creditors to the prejudice of the others, as the firm struggles to stay afloat.  (When it sinks, the rest of the creditors go down with it.)   The temptation to put the IRS at the end of the line is great. The IRS is unlikely to be aware that the firm is in difficulty, and if the firm decides therefore not to remit payroll taxes as they come due, but to favor the creditors who are threatening to seize the firm's assets or petition it into bankruptcy, the IRS is unlikely even to notice for some time that it is being stiffed. By the time it wakes up, the firm will probably be unable to pay the taxes that it failed to remit. It is to prevent firms from yielding to the temptation to put the IRS at the end of the creditor queue that Congress has imposed liability for nonpayment of payroll taxes on the responsible officers of the firm. For those persons to be insured against this liability will tempt them to do just what Opelika did here and what the penalty provision of section 6672(a) is designed to prevent-pay other creditors first, funding the preference by not paying the IRS at all. It would be ironic to use the IRS's policy of lenity in forgoing multiple collection of the statutory penalty to reduce the likelihood of its collecting the taxes for the nonpayment of which the penalty is imposed. 

 It is strongly arguable, indeed, that insurance against the section 6672(a) penalty, by encouraging the nonpayment of payroll taxes, is against public policy, so falling under the last clause of the policy exclusion and possibly under the rule in Illinois as elsewhere that forbids certain types of insurance as being against public policy because of the acute moral hazard that the insurance creates. A familiar example is taking out a life insurance policy on another person's life without his consent. But closer to this case is the rule that forbids insuring against criminal fines, a rule that Illinois courts have extended to punitive damages, We need not decide, however, whether insuring against the section 6672(a) penalty falls within this ban. For purposes of interpreting this insurance policy, a penalty is a penalty is a penalty.

A question I used to ask students:  Can you explain why the TFRP would be a penalty for D&O purposes whereas for other purposes it might not be a penalty (even though called a penalty in the statute)?

5.  I offer here the TFRP discussion from my current working draft of the 2018 FTP Book:

6.  The Court is correct in saying that § 7201 says nothing about tax deficiency.  Yet, many courts, including the Supreme Court, has named one of the elements of tax evasion under Spies as "tax deficiency."  That is not right as I have ranted before; the correct element is tax evaded or tax due and owing.  See e.g., For Tax Evasion, Is the Element "Tax Deficiency" or "Tax Due and Owing" (Federal Tax Crimes Blog 10/14/13), here; and John A. Townsend, Criminal Tax Sentencing: Fairness and Deterrence: Tax Evaded in the Federal Tax Crimes Sentencing Process and Beyond, 59 Vill. L. Rev. 599, 602-606 (2014), here.