Trust Fund Taxes – Trap for the Unwary
Sections 3402 and 3102 of the Internal Revenue Code require employers to withhold or deduct federal income and social security taxes from the wages of employees and to pay these taxes to the IRS on a quarterly basis. These taxes are commonly referred to as “trust fund” taxes because employers are required to hold these funds “in trust” for the benefit of the federal government.
It is very tempting for employers experiencing significant cash flow problems to raid these trust fund taxes for operational purposes with the expectation that they can replenish them before the quarterly payment is due. Frequently, insolvent employers will also use cash reserved for the payment of trust fund taxes to pay other creditors, such as critical vendors and secured lenders, rather than paying Uncle Sam.
Be wary of taking such actions, even in desperate times. You, as an officer, director or owner of the employer, may be personally liable for having to pay as a penalty the amount of trust fund taxes if the IRS determines that you are a “responsible person.” Section 6672 of the Internal Revenue Code (I.R.C.) imposes personal liability upon any person of a corporation, partnership, or limited liability company, who is responsible for collecting trust fund taxes and fails to remit such taxes to the federal government.
Courts have broadly interpreted “responsible persons” to include directors, officers, managers, employees and majority shareholders. A responsible person can be any person who has actual authority or maintains control over corporate finances, has a substantial ownership interest in the employer or has the authority over personnel decisions. See Jenkins v. U.S., 109 AFTR 2d 2012-XXXX, (CA Fed. Cir.), 06/08/2012 (holding that the majority owner, CEO and principal financier of a publishing corporation was a responsible person and was liable for willfully failing to pay withholding taxes); Birbari v. U.S., No. 11-8046, (10th Cir. 6-11-2012) (holding that the CEO of an LLC was personally liable for failure to pay payroll taxes). More importantly, personal liability for failure to pay trust fund taxes cannot be discharged in personal bankruptcy.
If you find yourself in a situation where you are deciding whether to pay your lender, critical vendors or the IRS, you should exercise caution and pay Uncle Sam. If you don’t, you may find yourself writing a personal check. For questions about this, or any other blog topic, please contact Dwight Wheaton at email@example.com or any of our Retail, Hotel & Restaurant team members.