The U.S. Supreme Court has decided not to review a federal appellate court ruling that upheld over $2.2 million in responsible person penalties against each of the four owners of a health care company and its accountant [Davis v. United States, U.S. Sup. Ct., cert. denied, Dkt No. 10-1328, 5/31/11].
Responsible person penalty. Under Code Sec. 6672(a), if an employer fails to properly pay over its payroll taxes, the 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. S.P. Davis, Willie Singleton, Phillip Pennywell, and James Williams (jointly, the owners) were equal owners, officers, and members of the board of Winward Institute, doing business as Winward Hospital (Hospital), Winward Health Care Center (Clinic), and Mynex (together, the companies). Mynex's management division performed all accounting functions for the companies, including, but not limited to, payroll, billing, accounts receivable, accounts payable, and reporting. From 1997 onward, Samuel Stevens served as the vice president of finance for Mynex.
Shortly after his hiring, Stevens learned that the companies were delinquent in the payment of their federal trust fund (employment) taxes. Stevens told the owners that he had entered into an installment agreement with the IRS and that current payroll taxes were being properly paid. The IRS disputes whether an installment agreement was actually consummated.
Throughout this time, the companies continued to make payments to outside creditors other than the IRS. Stevens admitted that, beyond discussing the matter with the IRS, he had done nothing to ensure that the companies' payroll taxes were being timely paid.
In the spring of 1998, the Hospital's creditors filed for bankruptcy. The IRS subsequently assessed responsible person penalties against each of the four owners, and against Stevens. The owners conceded that they were responsible persons (i.e., (1) above); however they contended that they did not act willfully in failing to remit the unpaid employment taxes (i.e., (2) above). Stevens argued that he did not meet either requirement to be classified as a responsible person.
Appellate court ruling. The appellate court had no trouble determining that Stevens met requirement (1) above, based on the fact that as vice president of Mynex, Stevens, by his own admission, authorized payroll checks, prepared federal payroll tax returns, authorized payment of federal tax deposits, reviewed federal income tax returns, directed the payment of bills, etc.
The court also concluded that all of the owners, and Stevens, willfully failed to pay the taxes. The court said that, even if an installment agreement existed, it was clear that the companies did not abide by it. The records showed that the companies fell further behind in paying the employment taxes due in the first three quarters of 1998 and the companies paid other creditors, rather than the IRS. There was also no evidence that the companies made progress in paying the delinquent taxes.
The owners argued that they made reasonable efforts to see that the trust funds were paid, by instructing Stevens and another Mynex officer to rectify the problem as soon as the owners learned that the employment taxes hadn't been paid. The court acknowledged that “reasonable cause may excuse the failure to collect, account for, or pay over withholding taxes,” but the mere delegation of responsibility to another does not constitute reasonable cause.
The owners also argued that they could not properly defend this case because the bankruptcy trustee destroyed the companies' records. The court refuted this argument by noting that two of the owners had been informed that the records were going to be destroyed, and there was no evidence that the owners had objected to the action.
See Davis v. United States, CA5, 106 AFTR 2d 2010-7128, 11/22/10, for further details on the appellate court's ruling.