The Trust Fund Recovery Penalty

A business that has employees is required by the Internal Revenue Code to withhold payroll taxes and income taxes from the wages of its employees and to pay those withheld amounts, called trust fund taxes, to the IRS. Pursuant to Section 6672 of the Internal Revenue Code:

“Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.”

To be liable under Section 6672, an individual must be (1) a "responsible person" and (2) the failure to collect, truthfully account for or pay over the tax must be "willful."

Courts have said responsibility is a matter of status, duty, or authority, not knowledge. A “responsible person” need not have exclusive control over the company’s finances; he need only have significant control. Other non-exclusive factors for courts to consider in determining whether a person is a responsible person include: (1) the contents of the corporate by-laws; (2) the ability of the individual to sign checks on the company’s bank account; (3) the taxpayer’s signature on the employer’s federal employment or other tax returns; (4) payment of other creditors in lieu of the United States; (5) the identity of the officers, directors and principal shareholders of the corporation; (6) the identity of the individuals who hired and fired employees; and (7) the identity of the individuals who were in charge of the corporation’s financial affairs.

Even if someone is a "responsible person", liability does not attach unless he also acted "willfully" by failing to pay the trust fund taxes over to the IRS. Responsible persons act "willfully" when they know or act in reckless disregard of the fact that taxes are due. The "reckless disregard" standard is met when a responsible person (1) clearly ought to have known that (2) there was a grave risk that withholding taxes were not being paid and if (3) the person was in a position to find out for certain very easily. Among the behavior recognized as willful is any payment to other creditors with knowledge that the employment taxes are due and owing to the Government.

A person who the IRS determines is liable for the Trust Fund Recovery (TFR) penalty under Section 6672 can challenge the determination by paying the trust fund portion for one employee for one quarter and filing a claim for refund. If the IRS denies the claim for refund, the person can file a refund suit against the IRS in U.S. District Court. In Richard W. Powell, Jr. v. IRS, No. 2:20-cv-01565 (W.D. Penn. 2024), that is exactly what happened. Powell was the general manager and operations coordinator for Michael’s Automotive Services (“MAS”), an auto repair shop that had unpaid employment taxes. After the IRS assessed the TFR against him in the amount of $442,058.66, Powell paid $225 and filed a claim for refund. When the IRS denied his claim for refund, Powell filed a refund suit in the U.S. District Court for the Western District of Pennsylvania.

In holding Mr. Powell was not liable for the TFR and ordering the IRS to refund the $225, the court said that Powell’s “job duties were akin to those of an errand boy carrying out everyday tasks at the direction of” MAS’s owner, rather than a responsible person willfully failing to pay over withheld federal taxes. The court found that Mr. Powell was not a responsible person because, (1) he was not an officer, director or shareholder of MAS, (2) he never prepared or signed any federal employment or other tax returns on behalf of MAS, nor was it within his job duties or authority to do so, (3) he did not have the authority to hire or fire employees at MAS, and there was no evidence that he ever did so, and (4) he did not have significant control over MAS or its finances.

Although Powell had opened an MAS bank account on which he was a signatory and had written checks, the court said this factor was not dispositive because the record established that Powell opened the account and wrote checks from the account only at the owner’s direction. In addition, the owner had the final word over which bills or creditors got paid from the account and Powell did not have significant control over those decisions. Finally, none of the checks he signed were used to pay taxes, and there was no contention that Powell was a signatory on any other MAS accounts.

The court also held that even if Powell was a “responsible person”, he did not act willfully, because he did not know or have any reason to know that withholding taxes were not being paid.

If you would like more information about this blog post or any other tax-related matter, please free to contact me at jcrouch@meadowscollier.com.