Wednesday, April 6, 2011

Trust Fund Penalty Applied Even Though No Funds Existed When Owners Discovered Embezzlement

Oppliger v. U.S. (CA 8 3/29/11), 107 AFTR 2d ¶2011-631

The U.S. Court of Appeals for the Eighth Circuit has granted summary judgment to IRS, finding that the owners of a company were responsible persons that had willfully failed to remit employment taxes. The Court rejected their argument that, when they regained control of their companies after their accountant had embezzled funds, their potential liability as responsible persons was limited to the unencumbered funds available at that time.

Responsible person penalty. Under Code Sec. 6672(a), if an employer fails to properly pay over its payroll taxes, IRS can seek to collect a trust fund recovery penalty equal to 100% of the unpaid taxes from a “responsible person,” i.e., a person who: (1) is responsible for collecting, accounting for, and paying over payroll taxes; and (2) willfully fails to perform this responsibility. In determining whether there is “willfulness” for purposes of Code Sec. 6672(a), the courts have focused on whether a taxpayer had knowledge about the non-payment of the payroll taxes, or showed reckless disregard with respect to whether the payments were being made.

The facts. In’92, James and Gayle Oppliger formed Double O, Inc. (Double O), a trucking business, and served as the sole owners and primary officers of the company. In’97, the Oppligers formed Livestock Feed Company, LLC (LFC). The Oppligers were the sole members of LFC.

In’96, the Oppligers hired Mary Kerkman to perform accounting and bookkeeping services for the companies. The Oppligers delegated to Kerkman the tasks of filing employment tax returns and paying payroll taxes. Kerkman provided the Oppligers with weekly reports that informed them of the companies' financial situations. Kerkman committed suicide on Apr. 3, 2002. After her death, the Oppligers learned that Kerkman had embezzled $10,000 from the companies.

On Apr. 4, 2002, the day after Kerkman's death, an IRS revenue officer informed the Oppligers that LFC employment taxes were not paid to the government for 13 consecutive quarters and Double O employment taxes were not paid for 17 quarters. The Oppligers claimed that this was when they first learned that Double O and LFC had not been paying employment taxes.

The Oppligers subsequently sold the assets of Double O on Sept. 1, 2002. Between Apr. 4, 2002 and Sept. 1, 2002, LFC paid $2,117,640.43 to its employees and $3,240,138.60 to third-party creditors. IRS then assessed penalties under Code Sec. 6672 against the Oppligers for LFC's unpaid taxes in the amount of $2,363,704.25, and Double O's unpaid taxes in the amount of $27,013.21. The Oppligers went to court to get relief.

District court decision. The Oppligers argued that they were not liable for the unpaid taxes because on Apr. 4, 2002, when IRS informed them of the outstanding tax responsibilities, they had bank balances of only $3,426.29 and $4,632.73, and had outstanding checks on both of the accounts. Relying on the Supreme Court's decision in Slodov v. U.S., (S Ct 1978) 42 AFTR 2d 78-5011, they claimed that their potential liability as responsible persons was limited to the unencumbered funds available on Apr. 4, 2002. They asserted that when they reassumed control of their companies, unencumbered funds didn't exist to pay the taxes owed.

In Slodov, the taxpayer assumed control of three corporations with outstanding trust fund tax liabilities and acquired funds which he used to pay employees' wages and other creditors. The Supreme Court held that a person responsible to collect taxes does not willfully fail to pay in withholding taxes by using funds for purposes other than payment of taxes when, at the time he assumed control, no funds existed to pay the outstanding tax obligations. The Supreme Court reasoned that the money generated after he became a responsible person wasn't directly traceable to the unpaid taxes and that a contrary interpretation would discourage changes of ownership and management of financially troubled corporations.

The district court granted summary judgment to IRS, stating that there were no genuine issues of material fact regarding whether the Oppligers were responsible persons under Code Sec. 6672. The district court further determined that the Oppligers willfully failed to pay the employment (trust fund) taxes because they admitted that after IRS informed them of their outstanding tax liabilities, they paid employees and third parties over $5 million. The Oppligers appealed the district court ruling.

Appellate Court decision. The Eighth Circuit held that the Oppligers were responsible persons under Code Sec. 6672 because they had the status, duty, and authority to pay the trust fund taxes. The Eighth Circuit refuted the Oppligers' claim that Kerkman's misconduct deprived them of the opportunity to make informed decisions by noting that whether Kerkman may have been a responsible person under Code Sec. 6672 is immaterial to the Oppligers' liability since they were both responsible persons for purposes of the penalty.

Further, the Eighth Circuit concluded that the Oppligers had willfully failed to pay the trust fund taxes. The Court found the Oppligers' reliance on Slodov to be misplaced. Slodov considered only the situation in which a change of control occurs within the corporation and a new person takes control at a time when a tax delinquency for past quarters already exists. In this case, the Oppligers were responsible persons during each of the quarters in which they failed to pay the employment taxes. Accordingly, the Oppligers' decision to pay employees and other creditors in lieu of IRS constituted a willful failure to pay taxes as a matter of law.

References: For who is a “responsible person,” see FTC 2d/FIN ¶V-1704; United States Tax Reporter ¶66,724; TaxDesk ¶864,005; TG ¶71654.

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