When federal income tax and/or federal employment taxes are withheld from employee paychecks but aren’t handed over to the government, a “100% penalty” can be assessed against a responsible person.
The purpose of this Trust Fund Recovery Penalty is to collect withheld but unpaid federal taxes from individuals who had control over an employer’s finances. It got its informal “100% penalty” name from the fact that the entire unpaid amount can be assessed against a responsible person (or several responsible persons).
Operating a business as a corporation often protects the individual owner from personal liability for some corporate debts. However, in cases of unpaid payroll taxes, the corporate shield or corporate veil is “pierced” and the IRS looks past the corporation to the responsible person to pay the debt.
Determining Who’s Responsible
The 100% penalty can only be assessed against a responsible person, which could be a shareholder, director, officer or employee of a corporation; a partner or employee of a partnership; or a member (owner) or employee of a multi-member LLC. It can also be assessed against an employee of a sole proprietorship or an employee of a single-member (one owner) LLC. The individual must meet the following requirements to be hit with the penalty:
1. Be responsible for collecting, accounting for, and paying withheld federal taxes, and
2. Willfully, not accidentally, fail to remit those taxes.
There must be knowledge of and control over the finances of the business to make a person responsible, not just the mere authority to sign checks when directed to do so by a superior. However, responsible person status can’t be deflected simply by assigning signature authority over bank accounts to another person in order to avoid the 100% penalty. As a practical matter, the IRS will look first and hard at individuals with check-signing authority.
The courts have examined several factors beyond the authority to sign checks when they determined who had responsible person status. Those factors include whether the individual:
- Is an officer or director,
- Owns shares or has an entrepreneurial stake in the company,
- Is active in managing the day-to-day affairs of the company,
- Makes decisions regarding which, when, and in what order debts or taxes will be paid,
- Exercises daily control over bank accounts and disbursement records, and
- Can hire and fire employees.
Outside Parties Can Be Responsible
Outside parties such as lenders and advisers can also be responsible persons in certain circumstances. For example:
1. A bank had the authority under a loan agreement with a delinquent corporation to oversee much of the corporation’s operations. It exercised this authority by honoring some checks but dishonoring others and was found by the IRS to be a responsible person.
2. The executor of a decedent’s estate was found to be a responsible person when the operators of an inn (which was an asset of the estate) failed to remit withheld federal taxes.
3. The president of a day care center’s board of directors, who wasn’t paid for his work and wasn’t involved in day-to-day operations, was held to be a responsible person because he secured loans for the center, directed its tax payments, and reviewed its financial reports. Therefore, he was found to be sufficiently involved in the center’s financial affairs to make him a responsible person.
4. A volunteer member of a charitable organization’s board of trustees had knowledge of the organization’s tax delinquency and authority to decide whether to pay the taxes. The individual was determined to be a responsible person by the IRS.
5. The executor of a decedent’s estate was found to be a responsible person when the operators of an inn (which was an asset of the estate) failed to remit withheld federal taxes.
More Horror Stories
CEO and CFO Were Responsible Persons. A corporation’s newly hired CFO became aware that the company was several years behind on its payroll taxes and notified the company’s CEO of the situation. The company’s board of directors was then informed by the CFO and CEO. The taxes weren’t paid although the company apparently had sufficient funds. After the CFO and CEO were both fired, the IRS assessed the 100% penalty against them both for withheld but unpaid taxes accrued during their tenures.
The First Circuit Court of Appeals upheld an earlier district court ruling that the two officers were responsible persons who acted willfully by paying other expenses instead of the federal tax liabilities. Therefore, they were both personally liable for the 100% penalty. (Schiffmann, 117 AFTR 2d 2016-386 1st Circuit, 2016)
Vice President and Co-Owner Was Responsible Person. A 40% stockholder and vice president of a corporation had an agreement with the 40% owner and president that the VP wouldn’t exercise independent authority over the corporation’s finances. The VP was responsible for running the shop and field operations but had check-signing authority only if the president was out of the office or unavailable.
However, the VP typically signed the field workers’ payroll checks and on one occasion signed the corporation’s federal payroll tax report. The VP also signed an IRS form stating that he was aware of an unpaid liability for withheld federal employment taxes.
The Federal Court of Claims concluded that he had the authority and responsibility to oversee the company’s financial obligations, despite the VP’s argument that he had no real control over corporate finances and that he didn’t focus on day-to-day administrative responsibilities. Therefore, he was found to be a responsible person and was personally on the hook for the 100% penalty. (Waterhouse, 116 AFTR 2d 2015-5080 Court of Federal Claims, 2015)
Whether or not you’re an owner or officer of the company, if you can be held personally liable for failure to remit withheld employment taxes, make sure that Uncle Sam is paid in a timely fashion! And keep in mind that in some cases, the IRS can go after several people.
Consult with your tax adviser about what records you should be keeping to avoid exposure to this expensive penalty. You may ultimately prove that you aren’t a responsible person if you’re tagged, but that could be expensive.