THE TRUST FUND RECOVERY PENALTY

The road to Hell, so we’re told, is paved with good intentions. And on the road to Hell, failure to pay employment taxes is definitely the fast lane. The resulting “trust fund recovery penalty” can spell disaster for the hard-pressed entrepreneur, corporate manager, director, officer, or employee who falls victim to it. This article will outline the exposure to the penalty, the procedures for contesting the penalty, and the options available for resolving the penalty once it has been assessed.

First let’s meet our cast of “characters,” starting with the villain, Snidely Fastcash. Snidely founded and is president of Scams-R-Us, Inc., an internet start-up based on creative accounting and investor gullibility. After running through all the venture capital money he could find, Snidely is faced on a daily basis with perilous choices. Without enough money to pay everything he owes, he has gone into survival mode — paying only those creditors who yell the loudest, or who could shut him down the quickest, hoping all the while to get that next big cash infusion. The employees need to be paid, or they will walk. So Snidely usually manages to come up with enough to meet the net payroll, but never quite enough to pay the withholding taxes. Making one’s federal tax deposits, after all, is a “voluntary” act. The IRS isn’t standing there each payday with a gun to Snidely’s head — that comes later.

Next enters our resolute hero, Revenue Officer Preston, with his faithful seeing eye sled dog, Yukon King. Preston demands immediate payment of the delinquent withholding taxes, but to his consternation the company just doesn’t have the cash. So after obtaining a Collection Information Statement (or CIS), Preston puts the company on an installment agreement which Snidely promptly defaults by failing to make yet more required payroll tax deposits. Now Snidely is a “repeater” who is “pyramiding” liabilities — a real bad actor (sorry) in the eyes of the IRS. Preston tells Snidely he’d like to shut down Scams-R-Us and sell off its furniture, but its just too darn much procedural trouble after the 1998 IRS Restructuring and Reform Act. However, he does manage to assess the trust fund recovery penalty against Snidely, his wife NormaLee Fastcash, and the company’s bookkeeper, Ima Patsy. NormaLee has nothing to do with her hubby’s business, but as far as the Maryland State Department of Assessments and Taxation is concerned she is an officer (secretary-treasurer). This is because Rex Barkely, Snidely’s lawyer, thought he needed a second person to name as an officer when he set up the corporation. Preston targeted poor Patsy because Snidely had made her a signatory on the corporate bank account, enabling her to sign checks (although only at his direction) when he and NormaLee were on their frequent trips to Aruba spending the investors’ money. But after Revenue Officer Preston starts enforced collection action on the TFRP assessment, Snidely feels his bacon starting to sizzle and he calls you for help. After collecting your retainer, what do you tell him? 2

Piercing the corporate veil

Corporations (and other limited liability entities) are creatures of the law. One characteristic of such entities is that creditors cannot “pierce the corporate veil” to reach the personal assets of the corporation’s stockholders, directors, officers or employees. That, of course, is exactly why Snidely structured his business as a corporation in the first place. But those who make the laws have cleverly provided exceptions for themselves. This corporate veil stuff might be fine for other creditors, but they certainly aren’t going to let it interfere with the collection of federal taxes. And so we have IRC §6672 and the “trust fund recovery penalty” (or TFRP). 3

Sec. 6672. Failure to collect and pay over tax, or attempt to evade or defeat tax.

(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.

The statutory phrase “equal to the total amount of tax . . . ” is why the TFRP used to be called the “100% penalty.” The TFRP leads to more litigation with the IRS than any other single provision of the Internal Revenue Code, and so each word and phrase has been fought over in the courts, and one can easily get lost in the forest of published opinions. The key elements, however, are as follows:

  • Responsibility — the subject had the duty to account for, collect, and/or pay over the trust fund taxes.
  • Willfulness — the subject “willfully” failed to collect, account for, or pay over trust fund taxes.

Each of these elements needs to be discussed in detail.

Responsibility

Most TFRP cases involve corporate officers like Snidely and NormaLee, but anyone who has the requisite degree of responsibility can be held liable, regardless of title. This includes a director who is not an officer or employee, as long as he was responsible for the corporation’s failure to pay withholding taxes. 4 An employee like poor Patsy can also be liable, even if she holds no corporate office whatsoever. The fact that an employee is normally under the control of the employer is not necessarily an excuse. Some courts have held that even an explicit order from a supervisor not to pay taxes does not relieve an otherwise responsible person from TFRP liability. 5 Also note that according to the Supreme Court, someone need not be responsible for all three of the duties listed in IRC §6672 (i.e. collecting, truthfully accounting for, and paying over). 6 Any one of these duties is sufficient to support a finding of responsibility. And more than one person can be responsible for the same withholding tax quarter. 7

Willfulness

The key question in determining liability for the TFRP is whether there was an affirmative decision not to pay the taxes. 8 In this context, willful means intentional, deliberate, voluntary and knowing. No evil intent or bad motive is required. 8 To prove willfulness, the IRS must merely show that the responsible party was aware of the outstanding taxes and either intentionally disregarded the law, or was plainly indifferent to its requirements. 10 A failure to investigate or to correct mismanagement after being notified that withholding taxes have not been paid satisfies the willfulness requirement. 11

After-acquired funds

A question that sometimes arises in TFRP cases is the exposure of a new manager or officer who arrives on the scene after payroll tax liabilities have already accrued. Though it may be hard to convince your friendly local revenue officer, the rule is that after-;acquired assets may be used to pay other creditors. However, if funds are available to pay delinquent taxes at the time the putative responsible person assumes control, and he then fails to use those funds to pay the delinquent taxes, he will become liable under §6672 to the extent of the funds that were available.

Computation of the TFRP

The trust fund recovery penalty covers only the “trust fund portion” of the corporation’s employment tax liability. In other words, only that which was withheld from the wages of employees and held “in trust” for payment to the government. This includes the withheld income taxes and the withheld FICA and Medicare taxes. On the other hand, it does not include the employer’s share of the FICA and Medicare taxes, nor does it include any of the interest and penalties which have accrued due to the employer’s nonpayment.

Even with this straightforward definition of the “trust fund” liability, computing the amount which is unpaid still requires an analysis of each payment made on the company’s withholding tax account for each quarter at issue. This is easy where no payments have been made. But payments, whether timely or late, must be allocated either to the trust fund portion or the nontrust fund portion of the liability. Here are the possible categories to which payments can be applied:

  1. Non-trust fund portion of tax
    (employer’s share of FICA and Medicare).
  2. Assessed lien fees and collection costs.
  3. Assessed penalties.
  4. Assessed interest.
  5. Accrued penalties to date of payment.
  6. Accrued interest to date of payment.
  7. Trust fund portion of tax
    (income tax and employee’s share of FICA and Medicare).

Next, here is the order in which various kinds of payments are applied to the categories listed above:

  • Federal tax deposit (timely or late)*
1 and 7
  • Partial payment on or before due date
1 and 7
  • Full payment on or before filing date
1 and 7
  • Partial payment after due date and before assessment
1, 5, 6 and 7
  • Partial payment on or after assessment
1 through 7
  • Involuntary payment (levy, etc.)
1 through 7
  • Designated payment
As designated

* A federal tax deposit in the required amount 12 will be considered a designated payment and applied to categories 1 and 7 for the tax period covered by the FTD.

A taxpayer making a voluntary payment may direct how it is applied, and the IRS must honor this designation. 13 In the absence of a designation, Rev. Rul. 73-305 provides that the payment be applied to tax, penalty, and interest, in that order, for the earliest year involved, and then in the same order to the succeeding years. Given the importance of the distinction between the trust fund and nontrust fund portions of the withholding tax in determining the amount of the TFRP, it is crucial for the protection of the potentially responsible persons that all payments be properly designated whenever possible. Indeed, using the right to designate to carefully channel available funds to the resolution of the trust fund liability can mean the difference between the client walking away from a failing business relatively unscathed, or being dragged down by an unmanageable burden which destroys the client and his family and thwarts any future attempt at financial resurrection.

Investigating the TFRP

The revenue officer assigned to collect the entity’s unpaid withholding taxes will also handle the TFRP investigation against any responsible persons who can be identified. In so doing, the revenue officer is instructed by the Internal Revenue Manual to consider a broad range of evidence, including: 14

  • Articles of incorporation, bylaws and minute books, which may show the names and duties of officers and directors; those responsible for filing returns and paying taxes; and those with authority to sign checks, deposit money, or borrow money.
  • Bank records and canceled checks, which may show the payment of other obligations after the taxes became due, and the names of those who made such payments.
  • Bank account signature cards, which will show those persons who were authorized to sign corporate checks.
  • Financial statements filed in connection with loans, which may provide information about responsibility and the financial solvency of the corporation.
  • Withholding and income tax returns, which may show the names of the officers and the person responsible for filing, the assets and income of the company, etc.

Despite the admonition to review a broad range of evidence, sadly revenue officers often limit their inquiries and their decisions to one grossly inadequate question: “who had signature authority on the company bank account?” To aid them in performing a more thorough analysis, and in particular to serve as an outline for interviews, the IRS provides Form 4180, called “Report of Interview Held With Individual Relative to Trust Fund Recovery Penalty or Personal Liability for Excise Tax.” The Manual instructs revenue officers to “conduct interviews with all potential responsible persons,” 15 and to cover the following:

  • Explain the TFRP.
  • Ask questions, gather information and documents in support of the penalty.
  • Advise all potentially responsible persons that they may be held liable.
  • Provide Notice 784, Could You Be Personally Liable for Certain Unpaid Federal Taxes . . . and sufficient copies to allow distribution to all other persons associated with the business who . . . may be liable.
  • Attempt to secure at least one Form 4180 from a potentially responsible person.
  • Inform the responsible person when the TFRP assessment will be made and of their appeal rights and that interest will continue to accrue on TFRP until paid and interest is computed from the date of the TFRP assessment to the date of the payment on the underlying trust fund liability.
  • Allow the taxpayer the opportunity to agree to the proposed assessment or to appeal.

The Manual also explains the proper use of the Form 4180, which revenue officers are told to secure from all potentially responsible persons. 16 A key point for those who represent taxpayers caught in the TFRP quicksand is that the Manual tells the revenue officer that he should fill out the Form 4180 himself, and should not give it to the taxpayer to complete. 17 Nevertheless, the Form 4180 is readily available, and in over 20 years of handling TFRP cases the author has never had a revenue officer refuse a Form 4180 prepared by counsel, or demand to personally interview the taxpayer when offered a completed form. On the contrary, revenue officers are usually glad to get a fully prepared and signed Form 4180.

This is very important because revenue officers are overworked and underpaid, and they aren’t really interested in long, complicated or nuanced explanations. Often a comprehensive and detailed answer will be summarized by the revenue officer on the Form 4180 with a shorthand phrase such as “taxpayer admits liability,” when this is not at all what the taxpayer said. For clients as to whom there is no real dispute about liability, this isn’t really a problem. But for those who in truth and fairness should not be held liable, overcoming this kind of administrative hatchet job after the fact can be very difficult. It is far better to avoid the problem in the first place by controlling the preparation of the Form 4180 if the revenue officer permits you to do so.

Also available is a seldom used companion to the Form 4180 — the Form 4181, Questionnaire Relating to Federal Trust Fund Tax Matters of Employees. This form contains questions similar to the Form 4180. However, it is meant for employees who are not necessarily liable for the TFRP themselves, but who can provide evidence the IRS can use to establish the liability of others.

As with the Form 4180, the Form 4181 can be used effectively by practitioners to clear those who should not be held liable, and to point the IRS in the right direction if someone else should bear responsibility. You may find yourself representing a bookkeeper like our Ms. Patsy, an employee who had check signing authority as a mere accommodation, someone like NormaLee who was an officer in name only, or perhaps even an active shareholder and officer whose duties simply did not involve the collection and payment of employment taxes (e.g. the typical “Mr. Inside” and Mr. Outside” arrangement). If so, you need to gather statements from other employees explaining who did what in running the business. After all, you don’t know and the revenue officer doesn’t know — neither of you were there. But what the revenue officer does know is that he will not rely solely on the statements of your client. The taxpayer, after all, has an obvious self-interest in minimizing his involvement in the business. Other employees, however, have no such axe to grind. Thus, if you have access to other employees, you can interview them yourself and then prepare Forms 4181 for signature using the information they provide. If you are defending your client against the assertion of the TFRP, or contesting it after assessment, preparing Forms 4181 for a few knowledgeable employees is preferable to leaving it up to the IRS to either ignore or mischaracterize this important testimony.

Collectibility determination

You should also know that the IRS has a policy of withholding assessment of the TFRP if it would be uncollectible. Accordingly, another way of defending a client against the penalty is to demonstrate that the assessment would be futile, and pointing to the relevant provisions of the Manual. Remember, the TFRP is not dischargeable in bankruptcy, so avoiding its assertion can spare the client a decade of pain and suffering. Here’s a portion of what the Manual has to say on this subject (and don’t assume that the revenue officer will know this unless you bring it to his attention): 18

The Trust Fund Recovery Penalty (TFRP) will normally not be assessed when the likelihood of successful collection is minimal. In every case . . . (d)etermine collectibility. Secure Form 433BA, Collection Information Statement (CIS), for individuals and/or 433BB, Collection Information Statement for Business. When a determination of present and future collection of TFRP is minimal, do not recommend assertion of the penalty.

The determination of ability to pay used here is not unlike that which you will encounter in other contexts, such as a request for an installment agreement or the analysis of an offer in compromise. The Manual instructs revenue officers to weigh the following factor “when considering non-;assertion of the TFRP:” 19

  • Current financial condition;
  • Involvement in a bankruptcy proceeding;
  • Income history and potential;
  • Asset potential (i.e. likelihood of increase of equity);
  • Prior TFRP assessments; and
  • Existence of prior currently not collectible cases.

The Manual presents several examples of cases in which assertion of the TFRP should be withheld because of collectibility. 20 Showing the revenue officer the similarities between your client’s case and the examples in his own Manual may make it easier for him to accept and justify the nonassertion of the TFRP. 21

Procedures for asserting the TFRP

If, despite your best efforts, the revenue officer decides that the TFRP is appropriate, he will prepare a Form 4183, Penalty Assessment Recommendation. 22 The Form 4183 is submitted to the group manager for review, and according to the Manual it must cover the following bases:

  • All persons considered for the TFRP must be listed, with a recommendation as to nonassessment or assessment (and the amount to be assessed).
  • Documented reasons for the assertion or nonassertion for each person considered, fully supported by the facts presented in the narrative and documentation.
  • A brief statement of facts concerning the responsibility and willfulness of each individual determined to be responsible, and adequate documentation.
  • Similar separate statements for each person considered but as to whom nonassertion is recommended.

Given the scope and significance of the Form 4183 and its attachments, it should always be secured through a Freedom of Information Act request in any case in which you are trying to contest the assertion of the TFRP, or in which you are seeking to overturn one that was already assessed.

Upon receiving a Form 4183, the group manager will review the case file. This review is another opportunity for vigorous and creative advocacy. But to be effective, you need to know what the group manager is looking for — and here it is: 23 The manager must address the same issues the revenue officer was supposed to address in the Form 4183, and in addition each question below:

  • Has collectibility been addressed?
  • Is the recommendation supported by adequate
  • Were all periods addressed?
  • Is the computation correct (i.e. is payment appli­cation in compliance with IRM guidelines)?
  • Are copies of all related tax returns in the file and have all returns been assessed or forwarded for assessment?
  • Does information submitted by the alleged responsi­ble person have any bearing on the recommendation, and have all issues been adequately addressed?

Your argument to the group manager that something has not been adequately considered is more likely to accomplish the desired result if couched in terms of (and with reference to) these requirements.

Right to an administrative appeal

If the group manager approves the assertion of the TFRP, the case is forwarded to the Collection Branch at the Service Center for computer input, and the procedures mandated by IRC § 6672(b) are followed. These include the issuance of a Letter 1153(DO) informing the taxpayer of the proposed assertion of the penalty, and providing an opportunity for him to file a protest letter seeking a confer­ence in the Appeals Office. No assessment may be made until 60 days after the mailing of this letter unless the taxpayer agrees to the assessment and affirmatively waives the 60 day period.

If a protest is filed, to be timely it must be mailed to the IRS on or before the 60th day after the IRS mailed the Letter 1153(DO). If the proposed TFRP is $10,000 or less, the protest can be informal. But if the amount in question is over $10,000, the protest must meet certain requirements. Specifically, it must be filed in duplicate and include the following:

  • A request for a conference in the appeals office.
  • The taxpayer’s name, address, and social security number.
  • The date and number of the IRS Letter protested.
  • The tax periods or years involved.
  • A list of findings with which the taxpayer disagrees.
  • An explanation of why the taxpayer should not be held liable for the penalty.
  • A Statement of Law citing the legal authority on which the taxpayer’s objection relies.
  • A Statement of Fact signed by the taxpayer as follows: “Under penal­ties of perjury, I declare that I have exam­ined the facts presented in this statement and any accom­panying informa­tion, and, to the b

The protest is reviewed first by the revenue officer handling the case, who is supposed to “determine if the information is com­plete as required by IRM 8.3.”If the revenue officer finds that the protest is in some manner incomplete, he or she will return it with a transmittal letter identifying the defi­ciency and explaining what else must be furnished. A period of 45 days is provided for the taxpayer to submit the additional information or documents so that the appeal request can be perfected and processed.

Upon receipt of the additional material, the revenue officer is supposed to review the new information. This informa­tion can then be used by the revenue officer either to further support his recommendation for the assertion of the penalty, or as the basis for conceding the case in whole or in part (with group manager approval). Usually the revenue officer determines that the appeal is acceptable, but that no new infor­mation has been pre­sented which would change his recommendation. In this case the revenue officer is supposed to send the taxpayer a Letter 1154(DO) stating that the case will be forwarded to the appeals office.

The revenue officer is also required to prepare a rebuttal to any new informa­tion provided by the taxpayer so that the rebuttal can be included in the package sent to the appeals office.The problem often encoun­tered in practice is that the revenue officer, upon receipt of the requested additional infor­mation, does nothing with the case for months on end. It takes time, after all, to review the new material and prepare a rebut­tal memorandum, and it is easier for an over­worked revenue officer to just let the case file sit. Meanwhile, the taxpayer and the practi­tioner, having filed a timely appeal request, are waiting for the matter to be assigned to an appeals officer, unaware that the case file is still sitting on the revenue officer’s desk.

Statute of limitations on assessment

The Internal Revenue Code contains a special statute of limitations on the assessment of the TFRP. Specifical­ly, the penalty must be assessed by the later of 3 years from April 15th of the year following the withholding tax quarter in ques­tion; or 3 years from the date the withhold­ing tax return was filed. However, this statutory assessment period can be extended in several ways, so determining the actual assessment bar date requires close attention to the facts. Events which extend the statute include the following:

  • The execution of Form 2750, Waiver Extending Statu­tory Period for As­sessment of Trust Fund Recovery Penal­ty.
  • The bankruptcy of the responsi­ble person (extends the stat­ute for the period of time the taxpayer is in bank­ruptcy, plus 60 days).
  • The issuance of a Letter 1153(DO) 60-day notice of the pro­posed assessment and the right to request an appeal (the statute will not expire before the later of 90 days from mailing, or 30 days after the “final admin­istrative determi­nation” is issued).

Certain other events, however, do not extend the statute of limitations on the TFRP:

  • The filing of an offer in compromise by the company.
  • The bankruptcy of the corporation.

In an effort to avoid missing the statutory assessment deadline, the IRS carefully tracks the limitations date, referred to in IRS-speak as the “As­sessment Statute Expiration Date” or ASED.

Assessing the TFRP

Once all appeals are exhausted and the relevant statutory periods have run, the IRS assesses the TFRP. In the past, the procedure was to make one assessment covering all applicable quarters. This assessment would be identified on the IRS computer using the latest quarter. Thus, a TFRP for the four quarters of 1998 and the first quarter of 1999 would result in one civil penalty (civ pen) assessment for the first quarter of 1999 (or 9903). In September 2001, however, the IRS began breaking this down and making separate assessments for each quarter.This should make it much easier for everyone involved to understand exactly which trust fund amounts are covered by the assessment.

The taxpayer is informed of the assessment by CP-15 notice from the IRS computer. Three weeks later the CP-504 notice is issued, and six weeks after that the account is assigned to the Automated Collection System (ACS) for collection action.

The TFRP, like other assessed taxes, is subject to a 10-year statute of limitations on collection.The 10-year period starts with the date of assessment, and can be extended by written waiver, the filing of an offer in compromise, the bankruptcy of the person against whom the penalty is assessed, a request for a collection due process hearing, or any of the other events which extend the statutory period for the collection of income taxes.

Refund claims and litigation

Once the TFRP is assessed, either before or after consider­ation in the appeals office, the next opportunity to contest it comes in the form of a refund claim. For income taxes, before a refund claim can be filed the entire tax liability must be paid.The TFRP, however, is a so-called “divisible” tax. This means that the trust fund amounts for each employee for each quarter are consid­ered separate items. And so a taxpayer can pay a portion of the TFRP corresponding to the

withholding tax for one employee for one quarter, and then file a refund claim seeking to recover that divisible portion of the liability — there is no need to wait until the entire TFRP assessment is paid. Indeed, waiting is danger­ous. The reason is that, like any other refund claim, a taxpayer is only entitled to recover amounts paid within 2 years of the date the refund claim is filed.So waiting to file a claim could result in part of the potential refund being time-barred.

If the IRS denies the refund claim or does not act on it within 6 months, a refund suit may be filed against the IRS in the appropriate U.S. District Court or in the Claims Court. Note that unlike dis­putes over proposed income tax assessments, TFRP litiga­tion does not occur in the U.S. Tax Court.

Abating the TFRP

Though called a penalty, the TFRP is a collection device, and IRS policy is to collect the unpaid trust fund taxes only once.Thus, if after the assertion of the TFRP the corpora­tion pays the delin­quent withholding taxes, the TFRP assessment will be abated.Converse­ly, payments on the TFRP result in credits against the corpora­tion’s underlying trust fund liabili­ty.And if the aggregate amount collected on the TFRP from one or more responsible per­son(s) exceeds what the corporation failed to pay, the excess will be refunded.

Treatment of the TFRP in bankruptcy

Section 507(a)(8)(C) of the Bankruptcy Code gives priority to all taxes “required to be collected or withheld and for which the debtor is liable in whatever capacity.” This includes the TFRP, effectively making it nondischargeable in the typical Chapter 7 case. Under some limited circumstances, however, the TFRP can be discharged in a Chapter 13 by using the “super­discharge” provisions of Bankruptcy Code 1328(a).

Often the IRS seeks to assert the TFRP against responsible persons for the unpaid trust fund taxes of a corporation which is in bankruptcy. The automatic stay provisions of the Bankruptcy Code do not prevent the IRS from assessing and collect­ing the TFRP from individuals who are not them­selves in bankruptcy. The IRS vigorously maintains that the bankruptcy court cannot enjoin the IRS from investigat­ing potentially responsible persons, assessing the TFRP against them, or collecting the TFRP, merely because the corporation which failed to pay its taxes is in bankruptcy.Nevertheless, absent statute of limitations consid­er­ations, it is generally the policy of the IRS to refrain from asserting the TFRP against responsi­ble persons in cases where the court has approved a corporate Chapter 11 plan of reorganiza­tion that provides for full payment of the taxes.

There has also been much debate over whether a Chapter 11 plan of reorganiza­tion can include a provision allocating corporate payments first to the trust fund portion of the unpaid taxes, thus reducing the exposure of the responsible officers as quickly as possible. Left to its own devices, the IRS would apply payments to the trust fund portion last so as to preserve its TFRP option as long as possible. The IRS sees any request to designate plan payments to the trust fund portion as an effort to burden it with the risk of nonpay­ment in the event the reorganiza­tion fails. Conversely, debtors argue that this is merely an attempt to keep managers from worrying about whether the IRS will collect the taxes from them before the plan of reorgani­zation can be complet­ed. The Supreme Court held in 1990 that bank­rupt­cy courts do have the authori­ty to approve Chapter 11 plans which order the IRS to apply corporate payments to the trust fund taxes if necessary for the success of the reorgani­zation plan.Neverthe­less, the IRS can still argue that in a given case the proposed designa­tion is not really essential to the success of the plan. Furthermore,

the courts are split on whether a plan can require the applica­tion of payments to the trust fund portion first when it provides for the corporation to be liquida­ted rather than reorganized.

Conclusion

Snidely, Shirley, and Ima Patsy are comic relief. But in the real world there is nothing funny about the trust fund recovery penalty. It usually comes as the business is sinking or already sunk — though far too often the business owner who has invested his entire economic and emotional life in his company refuses to believe that its over when its over. Instead, by failing to pay the trust fund taxes in a vain effort to turn things around, he goes down with the ship instead of living to fight another day. Nothing can drown a shipwrecked businessman quicker than the TFRP. It is the great white shark of the tax world, designed to scare people into compliance, and those who understand the impact of a massive nondischargeable TFRP assessment are right to be fearful. Rescuing an entrepreneur or corporate officer from the jaws of this tax monster can give him a new economic start. And saving someone who in fairness should not be held liable in the first place is the next best thing to what a Coast Guard rescue swimmer must feel when pulling a doomed sailor from an angry sea. All of this is possible if you have an adequate understand­ing of the IRC § 6672 penalty and the various administra­tive procedures and legal arguments available to contest it.

[1] Mr. Haynes is an attorney with offices in Burke, VA, and Burtonsville, MD, and is a member of the Maryland Society of Accountants’ Newsletter Committee. From 1973 to 1981 he was a Special Agent with the IRS Criminal Investigation Division in Baltimore, and in 1980 was named “Criminal Investigator of the Year” by the Association of Federal Investigators. He specializes in civil and criminal tax disputes and litigation, IRS collection problems, and the tax aspects of bankruptcy and divorce. (phone 703-913-7500; website https://www.haynestaxlaw.com/)

[2] This article focuses on the trust fund recovery penalty, a civil remedy. However, the IRS also has acriminal remedy available — the investigation and criminal prosecution of those engaging in willful failure to file payroll tax returns or willful failure to pay employment taxes. The IRS has recently decided to put more resources into the CID employment tax compli­ance program, and more criminal prosecutions are expected. For an explanation of CID’s efforts in this area, see the IRS CID website at www.ustreas.gov/irs/ci/tax_fraud/docemploymenttax.htm.

[3] Most states have similar laws. Indeed, state laws permit­ting corporate taxes to be collected from corporate officers and others are often more problematic than IRC §6672 because they don’t require a finding of “willfulness.” For example, §10-906(d) of the Tax-General Article of the Maryland Code imposes personal liabil­ity for failure to withhold taxes on any corporate officer who exercises direct control over fiscal manage­ment: “Maryland’s income tax withholding statute provides in relevant part that if a corporate employer negligently fails to withhold or to pay income tax . . . person­al liability for that income tax extends . . . to (i) any officer of the corporation who exercises direct control over its fiscal management; or (ii) any agent of the corporation who is required to with­hold and pay the income tax.” Lyon v. Campbell, 324 Md. 178, 596 A.2d 1012 (Md Ct. App. 1991). (Note: Messrs. Lyon and Campbell were fight­ing over who was respon­sible for the unpaid Maryland payroll taxes of their defunct company, Excava­tion-Construction, Inc. This fol­lowed their respective convictions for tax fraud, result­ing from an investi­ga­tion con­ducted by the author when he was a Special Agent with the IRS Criminal Investi­gation Division in Baltimore.)

[4] U.S. v. Graham, 309 F.2d 210 (9th Cir. 1962).

[5] Gephart v. U.S., 818 F.2d 729 (6th Cir. 1987).

[6] Slodov v. U.S., 436 U.S. 238 (1978).

[7] Thomas v. U.S., 41 F.3d 1109 (7th Cir. 1994).

[8] Brainstein v. U.S., 979 F.2d 952 (3d Cir. 1992).

[9] Domanus v. U.S., 961 F.2d 1323 (7th Cir. 1992).

[10] U.S. v. Landeau, 155 F.3d 93 (3d Cir. 1998).

[11] Finley v. U.S., 123 F.3d 1342 (10th Cir. 1997).

[12] See letter dated July 18, 2002, from AICPA Relations with the IRS Committee to IRS Deputy Commissioner Wenzel (www.cpa2biz­.com/ResourceCenters/Tax/Tax+Practice/TrustFund.htm).

[13] Quattrone Accountants, Inc., 88 B.R. 713 (B.C. DC Pa. 1988).

[14] Merchants National Bank of Mobile v. U.S., 878 F.2d 1382 (11th Cir. 1988).

[15] Slodov v. U.S., supra at footnote 6.

[16] Regs. §31.6302(c)B1 (and safe harbor rule).

[17] Tull v. U.S., 69 F.3d 394, 396-97 (9th Cir. 1995); U.S. v. Technical Knockout Graph­ics, Inc., 833 F.2d 797, 799 (9th Cir. 1987).

[18] IRM 5.17.7.1.4 (09-20-2000).

[19] IRM 5.7.4.1 (07-31-1998).

[20] IRM 5.7.4.1.1 (07-31-1998).

[21] IRM 5.7.4.1.1(1)(c) (07-31-1998).

[22] IRM 5.7.5.1 and 5.7.5.2 (07-31-1998).

[23] IRM 5.7.5.3 (07-31-1998).

[24] IRM 5.7.5.3(3) (07-31-1998).

[25] Obviously, all of this needs to be done gently. Revenue officers are used to dealing with taxpayers who never heard of the Internal Revenue Manual and know nothing of the statuto­ry restrictions on the IRS’s powers. When a representative starts spouting IRM references, some revenue officers feel threatened and react by saying “don’t tell me how to do my job.” Be sure of your facts and your legal grounds, and present your arguments in a professional and respectful manner. If the revenue officer then reacts inappropriately, take it up with his or her manager.

[26] IRM 5.7.4.6 (7-31-98).

[27] IRM 5.7.4.7 (07-31-1998).

[28] Any assessment made before sending the 1153(DO) must be abated. IRM 5.19.1.7.4.2 (10-1-2001) Jeopardy assess­ments, however, are not constrained by this 60-day notice requirement.

[29] IRM 5.7.6.4 (07-31-1998).

[30] IRM 5.7.6.5 (07-31-1998) states in part “(w)hen a pro­test­ed case is to be referred . . . the revenue officer will prepare a rebuttal memorandum which individually and thor­oughly addresses each issue raised in the responsible person’s protest; include information which supports the recommendation but which is not in the case file; reference additional evidence secured.”

[31] IRC §6501. For timely filed withholding tax returns, here’s an example of how the special limitations rule works:

1998 1st qtr Due date 4-30-1998 ASED 4-15-2002

1998 2nd qtr Due date 7-31-1998 ASED 4-15-2002

1998 3rd qtr Due date 10-31-1998 ASED 4-15-2002

1998 4th qtr Due date 1-31-1999 ASED 4-15-2002

Note: no assessment limitations period applies when a return is filed unsigned, or when a false return is filed, or when there is a willful attempt to evade tax. IRC §6501(c).

[32] IRC §6503(h).

[33] IRM 5.19.7.2.7(3) (10-10-2001).

[34] IRC §6502(a); IRM 5.17.7.1.10 (09-20-2000).

[35] See the author’s article on the statute of limitations on collection in the August-September 2002 issue of the Freestate Accoun­tant (also posted at www.https://www.haynestaxlaw.com/).

[36] See Flora v. U.S., 362 U.S. 145 (1960).

[37] See IRC §6511(b)(2)(B) and Kuznitsky v. U.S., 17 F.3d 1029, 1032 (7th Cir. 1994). However, IRC §6511(h) provides an excep­tion if the taxpayer was “financially disabled” during the applicable two-year period.

[38] See IRS Legal Memorandum ILM 200137021 (6-17-01).

[39] IRM 5.17.7.1.9 (09-20-2000).

[40] IRM 5.19.7.2.16 (10-10-2001); IRM 5.19.7.2.21(3)(a) (10-10-2001) et. seq.

[41] IRM 5.19.7.2.15(2) (10-10-2001). This is sup­posed to happen automatically. But in practice the sorry state of the IRS computer system means that getting the credits posted often requires repeated requests to the local Technical Support Unit (formerly called the Special Procedures Function).

[42] IRM 5.19.7.2.22 (10-10-2001).

[43] See the author’s article on discharging tax debts in bank­ruptcy in the February-March 1999 issue of The Free­state Accoun­tant (also posted at https://www.haynestaxlaw.com/).

[44] In re American Bicycle Assoc., 895 F.2d 1277 (9th Cir. 1990); U.S. v. Huckabee Auto, 783 F.2d 1546 (11th Cir. 1986); In re LaSalle Rolling Mills, 832 F.2d 390 (7th Cir. 1987); A to Z Welding & Mfg. v. U.S., 803 F.2d 932 (8th Cir. 1986).

[45] IRS Policy Statement P-5-60.

[46] This article focuses on the trust fund recovery penalty, a civil remedy. However, the IRS also has a criminal remedy available — the investigation and criminal prosecution of those engaging in willful failure to file payroll tax returns or willful failure to pay employment taxes. The IRS has recently decided to put more resources into the CID employment tax compli­ance program, and more criminal prosecutions are expected. For an explanation of CID’s efforts in this area, see the IRS CID website at www.ustreas.gov/irs/ci/tax_fraud/docemploymenttax.htm.

[47] Most states have similar laws. Indeed, state laws permit­ting corporate taxes to be collected from corporate officers and others are often more problematic than IRC §6672 because they don’t require a finding of “willfulness.” For example, ’10-906(d) of the Tax-General Article of the Maryland Code imposes personal liabil­ity for failure to withhold taxes on any corporate officer who exercises direct control over fiscal manage­ment: “Maryland’s income tax withholding statute provides in relevant part that if a corporate employer negligently fails to withhold or to pay income tax . . . person­al liability for that income tax extends . . . to (i) any officer of the corporation who exercises direct control over its fiscal management; or (ii) any agent of the corporation who is required to with­hold and pay the income tax.” Lyon v. Campbell, 324 Md. 178, 596 A.2d 1012 (Md Ct. App. 1991). (Note: Messrs. Lyon and Campbell were fight­ing over who was respon­sible for the unpaid Maryland payroll taxes of their defunct company, Excava­tion-Construction, Inc. This fol­lowed their respective convictions for tax fraud, result­ing from an investi­ga­tion con­ducted by the author when he was a Special Agent with the IRS Criminal Investi­gation Division in Baltimore.)

[48] U.S. v. Graham, 309 F.2d 210 (9th Cir. 1962).

[49] Gephart v. U.S., 818 F.2d 729 (6th Cir. 1987).

[50] Slodov v. U.S., 436 U.S. 238 (1978).

[51] Thomas v. U.S., 41 F.3d 1109 (7th Cir. 1994).

[52] Brainstein v. U.S., 979 F.2d 952 (3d Cir. 1992).

[53] Domanus v. U.S., 961 F.2d 1323 (7th Cir. 1992).

[54] U.S. v. Landeau, 155 F.3d 93 (3d Cir. 1998).

[55] Finley v. U.S., 123 F.3d 1342 (10th Cir. 1997).

[56] See letter dated July 18, 2002, from AICPA Relations with the IRS Committee to IRS Deputy Commissioner Wenzel (www.cpa2biz­.com/ResourceCenters/Tax/Tax+Practice/TrustFund.htm).

[57] Quattrone Accountants, Inc., 88 B.R. 713 (B.C. DC Pa. 1988).

[58] Merchants National Bank of Mobile v. U.S., 878 F.2d 1382 (11th Cir. 1988).

[59] Slodov v. U.S., supra at footnote 6.

[60] Regs. ’31.6302(c)B1 (and safe harbor rule).

[61] Tull v. U.S., 69 F.3d 394, 396-97 (9th Cir. 1995); U.S. v. Technical Knockout Graph­ics, Inc., 833 F.2d 797, 799 (9th Cir. 1987).

[62] IRM 5.17.7.1.4 (09-20-2000).

[63] IRM 5.7.4.1 (07-31-1998).

[64] IRM 5.7.4.1.1 (07-31-1998).

[65] IRM 5.7.4.1.1(1)(c) (07-31-1998).

[66] IRM 5.7.5.1 and 5.7.5.2 (07-31-1998).

[67] IRM 5.7.5.3 (07-31-1998).

[68] IRM 5.7.5.3(3) (07-31-1998).

[69] Obviously, all of this needs to be done gently. Revenue officers are used to dealing with taxpayers who never heard of the Internal Revenue Manual and know nothing of the statuto­ry restrictions on the IRS’s powers. When a representative starts spouting IRM references, some revenue officers feel threatened and react by saying “don’t tell me how to do my job.” Be sure of your facts and your legal grounds, and present your arguments in a professional and respectful manner. If the revenue officer then reacts inappropriately, take it up with his or her manager.

[70] IRM 5.7.4.6 (7-31-98).

[71] IRM 5.7.4.7 (07-31-1998).

[72] Any assessment made before sending the 1153(DO) must be abated. IRM 5.19.1.7.4.2 (10-1-2001) Jeopardy assess­ments, however, are not constrained by this 60-day notice requirement.

[73] IRM 5.7.6.4 (07-31-1998).

[74] IRM 5.7.6.5 (07-31-1998) states in part “(w)hen a pro­test­ed case is to be referred . . . the revenue officer will prepare a rebuttal memorandum which individually and thor­oughly addresses each issue raised in the responsible person’s protest; include information which supports the recommendation but which is not in the case file; reference additional evidence secured.”

[75] IRC §6501. For timely filed withholding tax returns, here’s an example of how the special limitations rule works:

1998 1st qtr Due date 4-30-1998 ASED 4-15-2002

1998 2nd qtr Due date 7-31-1998 ASED 4-15-2002

1998 3rd qtr Due date 10-31-1998 ASED 4-15-2002

1998 4th qtr Due date 1-31-1999 ASED 4-15-2002

Note: no assessment limitations period applies when a return is filed unsigned, or when a false return is filed, or when there is a willful attempt to evade tax. IRC §6501(c).

[76] IRC §6503(h).

[77] IRM 5.19.7.2.7(3) (10-10-2001).

[78] IRC §6502(a); IRM 5.17.7.1.10 (09-20-2000).

[79] See the author’s article on the statute of limitations on collection in the August-September 2002 issue of the Freestate Accoun­tant (also posted at https://www.haynestaxlaw.com/).

[80] See Flora v. U.S., 362 U.S. 145 (1960).

[81] See IRC §6511(b)(2)(B) and Kuznitsky v. U.S., 17 F.3d 1029, 1032 (7th Cir. 1994). However, IRC §6511(h) provides an excep­tion if the taxpayer was “financially disabled” during the applicable two-year period.

[82] See IRS Legal Memorandum ILM 200137021 (6-17-01).

[83] IRM 5.17.7.1.9 (09-20-2000).

[84] IRM 5.19.7.2.16 (10-10-2001); IRM 5.19.7.2.21(3)(a) (10-10-2001) et. seq.

[85] IRM 5.19.7.2.15(2) (10-10-2001). This is sup­posed to happen automatically. But in practice the sorry state of the IRS computer system means that getting the credits posted often requires repeated requests to the local Technical Support Unit (formerly called the Special Procedures Function).

[86] IRM 5.19.7.2.22 (10-10-2001).

[87] See the author’s article on discharging tax debts in bank­ruptcy in the February-March 1999 issue of The Free­state Accoun­tant (also posted at https://www.haynestaxlaw.com/).

[88] In re American Bicycle Assoc., 895 F.2d 1277 (9th Cir. 1990); U.S. v. Huckabee Auto, 783 F.2d 1546 (11th Cir. 1986); In re LaSalle Rolling Mills, 832 F.2d 390 (7th Cir. 1987); A to Z Welding & Mfg. v. U.S., 803 F.2d 932 (8th Cir. 1986).

[89] IRS Policy Statement P-5-60.

[90] IRM 5.17.10.9.5.3(b) (10-31-2000).

[91] U.S. v. Energy Resources, 495 U.S. 545 (1990).

[92] In re Kare Kemical, Inc., 935 F.2d 243 (11th Cir. 1991) (no designation allowed); In re Deer Park, Inc., 10 F.3d 1478 (9th Cir. 1993) (designation allowable).

[93] In re Kare Kemical, Inc., 935 F.2d 243 (11th Cir. 1991) (no designation allowed); In re Deer Park, Inc., 10 F.3d 1478 (9th Cir. 1993) (designation allowable).

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