Responsible Person Penalty: A Look at the Elements

By Mark A. Segal

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Over the past decade, substantial conflict has arisen between taxpayers and the IRS over the application of IRC section 6672(a), sometimes called the “100% penalty”:

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.

The IRC section 6672 penalty is assessed and collected in the same manner as the tax on which it is levied. The purpose of the penalty is to promote compliance with the duty to withhold and remit taxes from an employee’s paycheck. Thus, the IRS’s main target for collection of nonremitted sums is the person “responsible” for collection and remission.

Application of section 6672 necessitates ascertaining what constitutes a “responsible person”—because the penalty can apply only to responsible persons—and what constitutes willful failure to collect and remit, or failure to truthfully account.

A Question of Defense

The courts have broadly interpreted “responsible person” as those persons that possess either the actual authority or the capability of paying the tax. In addition, the expression has been construed to include persons that hold corporate office, maintain control over corporate finances, have substantial ownership interest in the entity, and have the authority to hire or fire.

As expressed in Denbo v. United States [98 F.2d 1029 (10th Cir. 1993)], check-writing authority is not a necessary condition, so long as one has significant authority (effective control) over corporate finances. In many instances, more than one person can be considered a responsible person.

For purposes of Section 6672, “willfulness” has encompassed “voluntary, conscious and intentional preference of other creditors over the government claims.” The expression also includes the failure to satisfy a duty to investigate or to correct faulty management upon being notified of failure to meet payroll obligations. Certain courts have indicated that reckless disregard or gross negligence may satisfy the willfulness criteria.

Metzger

In Thomas Metzger [No. 00-76820CIV-LENARD (U.S.D.Ct. S. Dist. of Florida, 2002)], the District Court, in remanding a case to the Bankruptcy Court, indicated that the burden of proof for avoiding assessed section 6672 penalties falls upon the taxpayer to establish that the taxpayer is not a responsible person or did not act willfully. The government is presumed to be correct in its assessment, and such presumption has been adopted by a majority of the circuit courts that have addressed the issue.

Nutt

The Bankruptcy Court typically becomes involved when a taxpayer files for bankruptcy and one of the claims for relief concerns an alleged IRC section 6672 penalty. Included among recent bankruptcy cases are: In re Ronald D. Nutt, et al. (88 AFTR2d 2001-5235) aff’d No. 6:02CV1346 (U.S.D. Ct. Mid. Dist., FL, 2003, United States v. Thomas J. Metzger, et ux. (No. 00-7682-CIV-LENARD), and In re Macagnone [85 AFTR2d Par. 2000-452 (2000)]. In each of these cases, the court ruled in favor of the taxpayer (although Metzger was overturned on appeal). The cases are instructive about possible arguments on behalf of the taxpayer.

In Nutt, the taxpayer asserted that he was not subject to the Section 6672 penalty because the failure to withhold was not willful. The case concerned a company formed by Nutt in 1975 in which he possessed “exclusive and direct management” until mid-1993, at which time another person was appointed to serve as president. Nutt returned to the position of president in May 1995. Payroll taxes were not paid until the end of 1995, after his return to the position of authority. During this period, Nutt did not sign payroll checks, 941 returns, or direct payments to be made to other creditors, nor did he participate in daily accounting, management, or operations. These duties were overseen by others.

Nutt was allegedly informed of the payroll tax problem in August 1995 through a memorandum, which he did not recall. An IRS revenue officer subsequently visited the company on October 31, 1995. Upon learning of this visit, Nutt made a personal loan to the company to pay the first quarter payroll taxes, because the company lacked adequate resources of its own.

Based on these facts, the court held that Nutt had not acted willfully and, therefore, was not subject to the IRC section 6672 penalty:

  • The burden of proof to show a lack of willfulness was upon Nutt, because Nutt stipulated that he was a responsible person.
  • Prior case law defined willfulness as being a “voluntary, conscious, and intentional act.”
  • Demonstrating a lack of willfulness requires an affirmative demonstration that no other creditors received preference over the IRS.
  • The lack of willfulness may be proven affirmatively if the person “did not disregard his duties, and that he undertook all reasonable efforts to see that such taxes would be paid in circumstances where the employer had the means of payment and could be reasonably expected to make such payment.” Merely establishing that taxes were owed and not immediately paid is not sufficient evidence of willfulness.
  • The facts revealed that during the period of 1975–1993—when Nutt was in control of the entity—payroll tax obligations were satisfied on a timely basis. Evidence also showed that Nutt acted promptly upon becoming aware of the problem. Nutt paid some of the liability with his own resources. Earlier, based on representations made to him, Nutt thought the finances of the company to be stable, and had no reason to believe there was a problem. Because Nutt did not allow the situation to fester or prefer other creditors over the IRS upon notice, it appears that he acted in good faith and did not willfully avoid the taxes.

Reckless Disregard

Identifying reckless disregard and whether it is adequate grounds for willfulness is an issue of some concern. Case law suggests that reckless disregard may satisfy the willfulness criteria. In Smith v. United States [894 F.2d 1549 (11th Cir. 1990)], as in Nutt, the defendant was established as a responsible person. The burden of proof then lay on the defendant to show that he had not acted willfully in failing to meet payroll tax obligations. In Smith, liability under IRC section 6672 was found; the person was considered to have acted with reckless disregard not only because he paid employees after learning of the payroll tax delinquency, but also because he ignored the company comptroller’s advice to look into the financial troubles.

In a similar manner, in Malloy v. United States [17 F.3d 329 (11th Cir., 1994)], the Eleventh Circuit Court of Appeals noted, “We hold that a responsible person is liable under section 6672 if he or she either had actual knowledge that taxes were not being paid or acted with a reckless disregard of a known or obvious risk of nonpayment.” In Malloy, the responsible person never asked if the taxes were paid or took notice of the obvious risk of nonpayment. In Wright v. United States [809 F.2d 425 (7th Cir. 1984)], the court indicated that gross negligence could be considered to meet the willfulness test.

Macagnone

Macagnone was a Chapter 7 bankruptcy case concerned with whether the court should discharge an IRS claim of the IRC section 6672 penalty. Examination of the facts resulted in the court finding Macagnone to be a responsible person, based upon his being a 50% shareholder, a principal in the corporation, technically authorized to disburse funds, and authorized to hire and fire employees. The court found willfulness to be lacking.

Citing the Eleventh Circuit decision In re Haas [48 F.3d 1153 (1995)], the Bankruptcy Court noted that “a debtor’s knowing failure without more, did not constitute a willful attempt in any manner to evade or defeat such tax.” In Macagnone, the taxpayer took corporate funds for personal use; although he did not take compensation during the period in question, he took sums to satisfy personal and business expenses. Likening the case to Haas, the court opined that although the priorities of the taxpayer may have been wrong, they did not rise to the level of willfulness. On appeal [86 AFTR2d Par. 2000-5076 (U.S. D.Ct., M.D., Fla., 2000)], the District Court affirmed the Bankruptcy Court’s decision. According to the court, the facts had not shown that the taxpayer had engaged in a conscious, knowing, and voluntary failure to pay. The ruling noted that the statute provides for neither gross negligence nor reckless disregard as grounds for satisfaction of the willfulness test.

Burden of Proof

In Metzger, the U.S. District Court for the Southern District of Florida remanded an IRC section 6672 case to the Bankruptcy Court, which had earlier ruled in the taxpayer’s favor. The District Court disagreed with the Bankruptcy Court over the initial burden of proof. The Bankruptcy Court’s position had been that the government bears the initial burden of proof concerning whether the taxpayer is a responsible person. Upon such burden being carried, the burden of proof shifts to the taxpayer to establish that the taxpayer had not acted willfully. The Bankruptcy Court’s position was premised upon the following language: “Once it is established that a taxpayer is a responsible person, the burden of proving lack of willfulness is on the taxpayer.” [See Mazo v. United States, 591 F.2d 1151 (5th Cir. 1979), and Thibodeau, 828 F.2d 1499 (11th Cir., 1987).]

In remanding, the District Court noted that the Eleventh Circuit had not actually placed the burden on the government to establish that the taxpayer is a “responsible person.” In the eyes of the District Court, the burden concerning whether the taxpayer constitutes a responsible person falls on the taxpayer. Liddon [448 F.2d 509 (5th Cir. 1971), cert. denied, 406 U.S. 918 (1972)] indicated that once an assessment of an IRC section 6672 penalty is made, the taxpayer bears the burden of establishing that she either is not a responsible person or did not act willfully.

IRC section 6672 contains one of the most severe penalties set forth in the Internal Revenue Code. The penalty serves as a major deterrent for taxpayers that fail to comply with their duty to withhold and submit payroll-related taxes. Planning accordingly and being aware of the parameters of a “responsible person” and a “willful” act may help avert subjection to audit and penalty.


Mark A. Segal, LLM, CPA, is a professor of accounting at the University of South Alabama, Mobile, Ala.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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