Who is Ultimately Responsible for Paying Payroll Taxes?

IRC §6672 states the following:

 (a)  General rule.

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. No penalty shall be imposed under section 6653 or part II of subchapter A of chapter 68 for any offense to which this section is applicable.

Now we enter the case of William R. Shore v. U.S.  A district court has denied a refund of a responsible person penalty that had been paid by the owner of a company who had delegated duties to a manager who ended up embezzling funds from the company. While the court sympathized with the owner, it found him liable for the penalty because he was a responsible person and he paid unsecured creditors after learning of the manager’s failure to pay IRS.

In determining whether an individual is a responsible person, courts consider factors including such as whether the taxpayer served as an officer of the corporation or a member of its board of directors, owned a substantial amount of stock in the company, participated in day-to-day management of the company, determined which creditors to pay and when to pay them, had the ability to hire and fire employees, or possessed check writing authority. Not every factor must be present, instead, a court must consider the totality of the circumstances to determine whether the individual in question had the effective power to pay the taxes owed.

William Shore (Shore) owned real property (the property) that he leased to Countryside Repair & Equipment (Countryside), a farm equipment seller, until late 2004 when Countryside closed. At the time Countryside ended its lease with Shore, a representative for McCormick Tractors, a line of tractors sold by Countryside, proposed that Shore start his own business on the property and become a McCormick dealer. Shore was initially uninterested because he was retired and lived far away. The McCormick dealer then suggested the manager of Countryside, Tom Lewis (Lewis), had 25 years of experience buying and selling tractors and could run the business for Shore.

Shore met with Lewis and ultimately decided to form Bear River Equipment, Inc. (BRE). Shore and Lewis verbally agreed that Lewis would run the business and have the option to purchase it at any time by repaying Shore’s initial $150,000 investment in the company with interest. Both parties believed that Lewis would eventually purchase BRE.

Pursuant to their verbal agreement, Shore hired Lewis to manage every aspect of the business, including day-to-day operations, financial management, purchasing of product lines, paying all of BRE’s bills, and other duties required to run an equipment sales business. Lewis was responsible for supervising, hiring and firing employees, as well as for submitting all tax forms for BRE and paying its payroll taxes. Shore viewed his role in BRE as an investor, and essentially treated the company as if it belonged to Lewis. Lewis and his wife also treated BRE as their own company and held themselves out to others, such as an accountant they hired to work for BRE, as the owners of the company. However, Lewis never exercised the option to purchase BRE.

Shore played a very limited role in the operation of BRE. But he signed the Articles of Incorporation as President of BRE, owned all of its shares, signed various contracts on its behalf as its president, and personally guaranteed an operating line of credit eventually obtained by BRE from a bank. Shore spoke by phone with Lewis once or twice a month to discuss operations and made quarterly visits to BRE to check inventory and generally assess the business. Shore also reviewed balance sheets and annual statements Lewis sent him for BRE.

Shore eventually noticed unpaid payroll obligations from 2005 and directed Lewis to pay them. Shore ensured Lewis paid the payroll obligations from 2005 by the January 2006 deadline. Shore had authority to sign checks on the bank account, though he did not write any checks on the account, and was listed on the check signature card as owner of BRE.

In August 2007, Shore received notice from IRS that there were serious issues with BRE’s employment taxes for 2006 and 2007. This was the first time Shore became aware that BRE’s 2006 and 2007 payroll taxes had not been paid. Shore subsequently learned that Lewis had been embezzling from BRE, failing to pay creditors or pay BRE’s taxes, and stealing BRE’s assets. Upon discovering Lewis’ fraud, Shore fired him and took over management of BRE. Shore ultimately decided to close BRE because he believed he could not pay all of the liabilities and contribute sufficient working capital to keep the company going. Before doing so, however, he allowed more than $120,000 from BRE’s checking accounts to be paid to unsecured creditors other than the U.S. Although Shore believed he should not be held liable for BRE’s unpaid payroll taxes because he was not a responsible party and did not willfully ignore tax obligations, he paid $101,583 in trust fund recovery penalties to the U.S. and later filed the instant suit to obtain a refund.

Here is the law, if you have a business and you have control of that business as an officer, shareholder, or make day to day decisions for a business, and you don’t pay payroll taxes, the IRS can access a Trust Fund Penalty against you personally.  Not paying your payroll taxes, is in fact embezzling money from the United States Treasury Department.  Because a corporation can go out of business, and wipe its debts clean, the IRS will issue a Trust Fund Penalty to protect the government’s interest and make sure that the amount will be paid back to the government.

The mistake that Shore made was that when he learned of the embezzlement of funds and the nonpayment of the payroll taxes, he paid unsecured creditors instead of paying the IRS.  The court concluded that the undisputed evidence established that Shore was a responsible person under Code Sec. 6672 . First, he was BRE’s president and signed contracts on its behalf as its president, including inventory agreements BRE needed in order to obtain the farm equipment it sold, and Shore also personally guaranteed such contracts. Shore also signed on BRE’s behalf and as its president when BRE opened a line of credit, which Shore personally guaranteed. Further, Shore was BRE’s sole shareholder. He thus had the effective power to change the company’s employees and thereby direct the business of the corporation. Shore also possessed, but did not utilize, check writing authority on BRE’s account with Ireland Bank.

Shore didn’t manage the day-to-day operations of the company or, at least while Lewis served as manager of BRE, determine which creditors to pay and when to pay them. However, Shore had monthly telephone calls with Lewis to discuss the business, made unannounced visits to BRE to assess inventory, and reviewed BRE’s financial statements.

When he learned that Lewis had not satisfied payroll liabilities in 2005, Shore called Lewis and ensured such liabilities were paid. Shore thus had the authority to order the payment of delinquent taxes. Thus, despite delegating his authority to Lewis and permitting him to run BRE’s daily affairs, Shore remained a responsible person because he had effective control of the corporation and the effective power to direct the corporation’s business choices, including the withholding and payment of trust fund taxes.

Shore was also ultimately responsible for hiring and firing Lewis.

The undisputed facts conclusively established that Shore possessed the status, duty, and authority necessary to be a responsible person under Code Sec. 6672 , as evidenced by his title, stock ownership, check writing authority, his ability to ensure that the 2005 payroll taxes were paid upon learning they had not been remitted, his authority to force the Lewis’s out of the business, and, perhaps most importantly, the fact that Shore ultimately took complete control over BRE once he learned of the tax liability. Therefore, the court found Shore was a responsible person as a matter of law.  Even if you have directed an employee to make the payments to the IRS and they fail to do so, you could be held liable like Mr. Shore.

The question would arise: why doesn’t the IRS go after Lewis for his failure to pay the payroll taxes?  Very simply, they determined that they could get the money out of Shore and not Lewis.  Does Lewis have some responsibility?  Yes he does.  If this had happened where Shore never had any idea of what was going on, and the IRS came in to assess the Trust Fund Penalty, they would have probably assessed the penalty against Lewis as Shore had no idea that the taxes had not been paid.

When dealing with payroll taxes, the IRS doesn’t play around.  Be very careful.  If you find yourself in a similar situation, give us a call at 1-855-IRS-2-911.