Certain tax violations carry significantly more severe consequences than others. A prime example is the failure to remit federal income and employment taxes withheld from employees’ paychecks. In such cases, the IRS may impose the Trust Fund Recovery Penalty, commonly referred to as the 100% penalty.
This penalty is termed the 100% penalty because it allows the IRS to hold a responsible individual – or multiple responsible individuals – personally liable for the full amount of unpaid federal income and payroll taxes.
Determining responsible person status
Since the 100% penalty can only be assessed against a so-called responsible person, who does that include? It 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 an LLC. To be hit with the penalty, the individual must:
- Be responsible for collecting, accounting for, and paying over withheld federal income and payroll taxes, and
- Willfully fail to pay over those taxes.
Willful means intentional, deliberate, voluntary and knowing. The mere authority to sign checks when directed to do so by a person who is higher-up in a company doesn’t by itself establish responsible person status. There must also be knowledge of and control over the finances of the business. However, responsible person status can’t be deflected simply by assigning signature authority over bank accounts to another person in order to avoid exposure to the 100% penalty. As a practical matter, the IRS will look first and hard at individuals who have check-signing authority.
What courts examine
The courts have examined several factors beyond check-signing authority to determine responsible person status. These factors include whether the individual:
- Is an officer or director,
- Owns shares or possesses an entrepreneurial stake in the company,
- Is active in the management of day-to-day affairs of the company,
- Can hire and fire employees,
- Makes decisions regarding which, when and in what order outstanding debts or taxes will be paid, and
- Exercises daily control over bank accounts and disbursement records.
Real-life cases
The individuals who have been targets of the 100% penalty are sometimes surprising. Here are three real-life situations:
Case 1: The operators of an inn failed to pay over withheld taxes. The inn was an asset of an estate. The executor of the estate was found to be a responsible person.
Case 2: A volunteer member of a charitable organization’s board of trustees had knowledge of the organization’s tax delinquency. The individual also had authority to decide whether to pay the taxes. The IRS determined that the volunteer was a responsible person.
Case 3: A corporation’s newly hired CFO became aware that the company was several years behind in paying withheld federal income and payroll taxes. The CFO notified the company’s CEO of the situation. Then, the new CFO and the CEO informed the company’s board of directors of the problem. Although the company apparently had sufficient funds to pay the taxes in question, no payments were made. After the CFO and CEO were both fired, the IRS assessed the 100% penalty against both of them for withheld but unpaid taxes that accrued during their tenures. A federal appeals court upheld an earlier district court ruling that the two officers were responsible persons who acted willfully by paying other expenses instead of the withheld federal taxes. Therefore, they were both personally liable for the 100% penalty.
Don’t be tagged
If you are involved in the operation of a business or any entity that has failed to remit federal taxes withheld from employee paychecks, you may be at risk of being designated by the IRS as a “responsible person” and subjected to the 100% penalty. While it is possible to establich that you are not a responsible person, the process can be complex and costly. To mitigate this risk, please consult with your Rudler, PSC advisor to ensure you are maintaining proper records and taking the necessary precautions to avoid potential liability for the 100% penalty. Contact us at 859-331-1717.
RUDLER, PSC CPAs and Business Advisors
This week's Rudler Review is presented by Brandon Hughes, Staff Accountant and Evan Kandra, CPA.
If you would like to discuss your particular situation, contact Brandon or Evan at 859-331-1717.
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