Many financially distressed companies accumulate large liabilities for employment taxes withheld from their employees’ wages. These taxes can be assessed personally against the company’s principals.
When a company fails to pay its Federal employment taxes, the trust fund portion of those taxes can and will be assessed personally against the business’s “responsible persons” (such an assessment is called a “trust fund recovery penalty”). “Trust fund” taxes are those that the employer is required to withhold from employees’ wages and pay over to the IRS. They include withheld income tax, Social Security tax, and Medicare tax. Many states, including Michigan, also impose a trust fund recovery penalty for state income tax withheld from employees’ wages but undeposited with the state taxing authority.
A responsible person is one who decides how the company uses its available cash. In the IRS’ view, one who has the right to determine how a company uses its cash, even though he or she does not exercise that right, can be a responsible person. Signature status over a company’s bank accounts is a telling indicia of responsible personhood. A company’s chief executive officer is nearly always deemed a responsible person.
Every company has at least one responsible person. Heroic efforts to prevent assessment of a trust fund recovery penalty usually are not worth it. It is much more worthwhile to endeavor to confine assessment of a trust fund recovery penalty to one, truly responsible, person, and to start the collection statute of limitations running on the assessment.
Within about six months after a company fails to file an employment tax return, or fails to deposit employment taxes with the IRS, an IRS Revenue Officer will contact the company and attempt to bring it into compliance with the law. If that doesn’t work, the Revenue Officer will initiate a trust fund recovery penalty assessment, beginning with interviews of suspected responsible persons. It is critically important that such persons immediately retain qualified counsel, and that the interviews not take place. A target’s representative can instead complete a questionnaire for the target and submit it to the Revenue Officer.
If a target disagrees with a proposed trust fund recovery penalty assessment against him, he or she can appeal the proposed assessment to the IRS Office of Appeals. If that is unsuccessful, the trust fund recovery penalty will then be assessed. Upon assessment, a tax lien in the amount of the trust fund recovery penalty arises in favor of the IRS on all of the taxpayer’s property. The IRS will record notice of the tax lien in the local register of deeds’ office, disabling the assessed target from selling or mortgaging real property.
The statute of limitations on collection is 10 years from the date of assessment for a Federal trust fund recovery penalty, and six years from the date of assessment for a Michigan trust fund recovery penalty. Neither Federal nor state trust fund recovery penalties are dischargeable in bankruptcy.
A target against whom a trust fund recovery penalty has been assessed can litigate the assessment by paying trust fund tax for at least one employee for at least one calendar quarter (this is called a “divisible portion” of the assessment), and then filing a claim for refund of it with the IRS. Once the IRS denies the claim, or six months pass without IRS action on the claim, the target may sue in U.S. District Court, challenging the trust fund recovery penalty assessment.
The IRS can criminally prosecute a failure to deposit withheld trust fund taxes, and in the present economy it is doing so with increasing frequency. A well-known Michigan restauranteur recently pleaded guilty in U.S. District Court in Detroit to a prosecution for failing to deposit trust fund taxes withheld from his employees’ wages.
Several things can and should be done to protect a company’s principals from trust fund recovery penalty assessments:
* The company’s CEO should monitor the company’s trust fund obligations and determine that they are being paid on a current basis.
* As soon as the company determines that it may not be able to fully pay its employment tax obligations as they accrue, the company should─
- prepare to cease operations as soon as possible; and
- specifically allocate any further payments of employment taxes as against the company’s trust fund obligations.
