Trust Fund Penalty – Tax Court Case McCloskey v. US. 104 AFTR 2d 2009-6378
22 Jun Trust Fund Penalty – Tax Court Case McCloskey v. US. 104 AFTR 2d 2009-6378
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Employment Tax,
IRS Penalties,
IRS Penalty and Interest Abatement,
Payroll Tax Problems,
Self Employ,
Small Business,
Social Security Tax,
Sole Proprietor,
Sub-chapter S,
Tax Abuse,
Trust Fund Recovery Penalty
by John R. Dundon II
Shareholder Timothy McCloskey was assessed a trust fund penalty due to an unfortunate problem he had with his trusted bookkeeper and chief financial officer, Kathleen Lawson.
On September 1, 2004, Kathleen left Timothy an apologetic letter of resignation. Upon reading it, Timothy knew that she had embezzled funds, but did not know how much. He immediately made an inquiry to the IRS and was informed, by letter, that employment tax returns had not been filed for 19 quarters.
Within a month of her departure, Timothy was able to determine the amount of Kathleen’s embezzlement from his company to be approximately $800,000. However, it took Timothy and his relatives several months to figure out where Kathleen hid the IRS notices. They eventually discovered the completed tax returns and IRS delinquency notices hidden in the ceiling tile in Kathleen’s former office.
Once Timothy became aware of the magnitude of Kathleen’s embezzlement, he knew he could not keep his corporation in business. He consulted his attorney about filing for bankruptcy, but was told he did not have the necessary assets to file for bankruptcy. His attorney further advised him to begin winding down the business by paying his creditors, employees, and himself at a reduced rate. Following his attorney’s advice, he paid out over $348,320 to the corporate creditors, vendors, employees, and himself. But he did not pay the $268,377 in delinquent employment tax to the IRS.
On November 1, 2004, Timothy began liquidating the corporation. He entered into an agreement to sell the inventory for $240,000. He used those proceeds to pay off a personally secured corporate loan. Between September 3, 2004, and January 31, 2006, Timothy’s corporation paid out $828,143 from funds the corporation received for goods and services provided prior to September 6, 2004.
Finally, on March 1, 2005, Timothy signed and mailed the Form 941 employment tax returns for the 19 delinquent quarters. On September 12, 2005, the U.S. Treasury made assessments against Timothy, pursuant to §6672, for failure to truthfully account for or pay over the federal income and employment taxes withheld from the wages of his corporate employees for the 19 quarters at issue.
He paid $51,302 to satisfy the debts for the three tax periods ending June 30, 2000, through December 31, 2000. However, that still left $325,695 to be paid for the remaining 16 quarters in addition to penalties, accrued interest, and costs. Accepting the fact that he was a “responsible person,†Timothy claimed he did not willfully fail to pay the $268,377 of withholding taxes and therefore is not personally liable. He cited numerous cases to avoid the “willful†label, but the
Tax Court did not agree with his interpretation.
After learning of the tax delinquencies, and before remitting a partial payment to the IRS, Timothy paid “substantial sums†to creditors other than the IRS, even after receiving an IRS letter verifying that taxes were owed. The fact that he did not know the exact amount due was not considered a valid excuse.
However, the Tax Court stated that willfulness is established when a responsible person uses corporate funds to satisfy debts with other creditors after acquiring knowledge of an IRS delinquency. No evil motive or fraudulent purpose is needed. Timothy’s status as sole shareholder and company president came with a duty to ensure that trust taxes were in fact being remitted by his company. He crossed the line as soon as he paid other creditors first instead of satisfying the employment tax debt to the IRS.
Every employer has the responsibility to deposit trust fund taxes in a timely manner. Those funds are not to be used for any other purpose as the employer has been so entrusted.
