The New Federal 'Authorized Tax Practitioner Privilege'
A minefield waiting to explode
BY JOHN G.DELANCETT, ESQ.
Recently, partially in reaction to substantial adverse publicity against the Internal Revenue Service and partially in response to pressure brought by the accounting profession, Congress adopted a new Internal Revenue Code, section 7525 entitled "Confidentiality Privileges Relating to Taxpayer Communications." Subsection (a)(1) of the new section extends the common law protection of confidentiality existing between a taxpayer and an attorney to include those communications between a taxpayer and "any federally authorized tax practitioner" to the same extent that communications would be considered privileged between a taxpayer and an attorney. Subsection(a)(3)(A) defines federally authorized tax practitioner as any individual authorized under Federal law to practice before the Internal Revenue Service, if such practice is subject to regulation under section 330 of title 31, United States Code. Tax advice is defined in sub-section (a)(3)(B) as advice given by an individual that is within the individual's scope of authority to practice as described in subparagraph (A).
Background
Prior to the enactment of this statute, no accountant-client privilege existed under Federal law [Couch v. United States, 409 U.S. 332,34L. Ed. 2d 548, 93 S. Ct. 611 (1973)]. In fact, anyone who prepared returns - including attorneys - was deemed not to have engaged in the rendering of a legal service; therefore, any communications relating to the preparation of a return was not privileged [In Re Grand Jury Investigation (Schroeder), 842 F.2d 1223, 1224-1225 (11th Cir. 1987)]. As a result, attorneys customarily retain accountants to assist them in litigation, whether civil or criminal, under the concept that since they are assisting attorneys in giving advice to the attorney's client, the accountants' reports are part of the attorney work product and all communications are therefore privileged. Such accountants are commonly referred to as Kovel Accountants after the case of United States v. Kovel, 296 F. 2d 918, 921 (2d Cir. 1961). In which this relationship was first recognized and approved.
Impact of the Statute
However, anyone believing that this new statute has now eliminated the need for such arrangements may find themselves sorely disappointed. Subsection (a)(2), "Limitations," states that the privilege can be asserted only in: 1) any non-criminal tax matter before the Internal Revenue Service; and 2) any non-criminal tax proceeding in Federal Court brought by or against the United States. Accordingly, accountants must engage in "crystal ball-gazing" in determining whether or not the matters in which they may be engaged could ever result in criminal proceedings. Accountants must also gaze further into the crystal ball to determine whether any federal agency (other than the IRS) might be interested in the communications about to take place, as the matters must be tax proceedings or tax matters in order for the privilege to apply.
The example given by the United States Senate in its report [Sen Rept No. 105-174, (PL 105-206)] is that the Securities and Exchange Commission's ability to gain or to compel information was in no way changed by the new provision and that the privilege could not be asserted in dealings with any such regulatory body in an administrative or court proceeding.
Additionally, the Senate Report opines that the distinction between legal advice and the preparation of a tax return will continues and, accordingly, that any information disclosed to an attorney, certified public accountant, enrolled agent, or enrolled actuary will not be privileged under this statute.
Finally, subsection (b) of the new statute clearly provides that the new privilege is not to apply to any written communications between a federally authorized tax practitioner and any director, shareholder, officer, employee, agent, or representative of a corporation engaged in the promotion of the direct or indirect participation of any such corporation in any tax shelter.
Quite frankly, the most challenging exercise to be performed is to determine to what circumstances the privilege does, in fact, apply. Great caution in relying upon this new privilege in communications with taxpayers must and should be exercised. The new statute, instead of being a benefit to the accounting profession, may in fact become a new predicate for more malpractice claims.
John G. DeLancett is an Orlando, Fla., attorney admitted to practice before the U.S. District Court for the Middle and Northern Districts of Florida, the U.S. Supreme Court, the U.S. 5th and 11th Circuits Court of appeals, the U.S. Tax Court and all Florida Courts. He practices in the areas of commercial litigation and personal injury litigation with emphasis in civil and criminal tax litigation and administrative law.
Reprinted from the January 1999 CPA Litigation Service Counselor, Volume 1999, Issue 1, pg.7.
Florida Sales Tax Prosecutions - The Other Tax Fraud
By John G. DeLancett
The term "tax fraud", for most practitioners, brings to mind images of Internal Revenue Service special agents, Department of Justice attorneys, and criminal charges arising under Titles 26 and 18 of the United States Code. In Florida, where there is no state income tax, few think of criminal prosecutions arising from state tax issues. Yet, Florida does actively prosecute sales tax violations.¹
In fiscal year 1992-92, the Florida Department of Revenue, Bureau if Enforcement, Criminal Investigations, assigned 766 cases to its agents, resulting in 87 prosecutions and 64 convictions. The first six months of 1994-95 saw 394 assigned investigations, 37 prosecutions, and 17 convictions. The bureau proudly points out that the amount of restitution collected nearly doubled in 1993-94, to wit: $917,000 versus $508,000; and, in the first six months of the 1994-95 year, over $438,500 was collected.²
Unlike the federal system, where the Freedom of Information Act has made available the Internal Revenue Manual, the Special Agent's Handbook, and the Department of Justice Manual, there are no published criteria setting forth when the state will pursue a sales tax violation as criminal. Discussions with state investigators concerning such criteria have proven to be vague, nonspecific, and disheartening with general response being "find us before we find you and pay your tax."
To advise a client concerning possible criminal exposure, it is important to understand the multitude of sales tax offenses provided under the Florida Statutes. While the following is not an exhaustive list, it provides an overview of there potential charges:
1) Section 212.07(3) provides that failure, neglect, or refusal to collect sales tax is a misdemeanor.
2) Section 212.07(4) punishes representations by a dealer that he or she will absorb or pay sales tax.
3) Section 212.085 prohibits anyone from fraudulently, for the purpose of evading tax, issuing a written certificate or statement claiming exemption from sales tax.
4) Section 212.10 provides that, upon sale of a business having a tax liability and upon receipt from the department of notice of same, failure to timely pay the tax is a misdemeanor.
5) Section 212.12(2)(a) prohibits the filing of a false or fraudulent return or willful intent to evades taxes.
6) Section 212.13(1) makes it a misdemeanor to fail to maintain books and records, or to provide them to the department for inspection upon demand.
7) Section 212.14(3) provides that it is a misdemeanor for a corporate officer to refuse to make a sales tax return or to pay sales tax owed by a corporation.
8) Section 212.18(3)(a) provides that failure to register as a dealer is punishable as a misdemeanor.
9) Section 832.062(1) makes it a crime to issue a check, draft, or written order for payment of tax to the department knowing that there are insufficient funds to pay same. If the amount is less than $150, it is a second degree misdemeanor; if more than $150, it is a third degree felony.
10) Section 812.014, the general theft statute, is also used to prosecute sales tax theft, often by the statewide prosecutor's office.³ However, since the statute closely mirrors §212.15, the taxpayer cannot be found guilty under both statutes. See Carawan v. State, 515 So. 2d 161 (Fla.1987), and Vittorino v. State, 538 So. 2d 98 (Fla. 3d DCA 1989).
11) Last, but not lest, §212.15, failure to remit collected funds, provides that whoever, with intent to unlawfully deprive the state of it's sales tax, fails to pay over collected sales tax, is guilty of theft of state funds. The severity of punishment is tied to the amount involved and the number of convictions: Subsection 2(a) provides that if the taxes are less then $300, it is a second degree misdemeanor; upon a second conviction, it is a first degree misdemeanor; and on a third conviction, a third degree felony. Subsection 2(b) provides that if the amount is between $20,000 to $100,000, it is a second degree felony. Subsection (2)(d) provides that if the taxes exceed $100,00, it is a first degree felony.4
A review of the penalties set out in F.S. §§ 775.082 and 775.083 make it immediately apparent that these offenses can be serious. Fro example, a conviction under § 212.12(2)(d), punishable as a first degree felony, could result in 30 years' imprisonment and a $10,000 fine. Knowledge of the potential penalties involved is required so as to advise the client concerning the statutes of limitations.
F.S. § 775.15 provides the time limits for prosecutions, unless otherwise specified by the criminal statute involved. A first degree felony must be prosecuted within three year. A first degree misdemeanor must be prosecuted within two years, while a second degree misdemeanor must be prosecuted within one year. However, subsection (3)(a) provides that if the period has expired, a prosecution may, nevertheless, be commenced for an offense in which a material element is fraud, within one year after discovery of the offense. In no event can this provision extend the base period by more than three years. Accordingly, the practitioner must determine whether fraud is a requisite element of the particular offense.
The practitioner must also be aware that § 212.15 (Theft of Sales Tax) contains a specific statute of limitations of two years for misdemeanor violations, and five years for felony violations. The Florida courts have held that the offense of evasion of payment of sales tax is committed when the taxpayer was required to pay the sales tax, to wit: no later than the 21st day of the month succeeding the month for which the taxes were collected. See Farhud v. Clark, 399 So. 2d 1079 (Fla. 1st DCA 1981).
As in any case, counsel must understand the investigative process and the persons involved in it. The Bureau of Enforcement, Criminal Investigations, conducts criminal tax investigations. The director of Collection and Enforcement is assisted by the chief of the Bureau of Enforcement, Criminal Investigations. The current chief is David Skinner. There are presently 50 investigators assigned to the criminal investigation function. While the number has remained stable for the last two years, it has increased dramatically as compared to a few years ago. The criminal investigation offices are maintained at 10 different locations throughout the state, with a new one to be opened in the Jacksonville area very soon .5
Experience shows that these criminal investigators are not highly trained in tax issues nor as prepared as the special agents one encounters in federal tax enforcement matters. Oftentimes, the state investigators are former fraud investigators from various state attorneys' offices who have been "re-tooled" to work in the criminal tax arena. The notable exception is when the investigation is conducted by the Florida Department of Law Enforcement, statewide prosecutor's office. These investigations arise when a major case involves multiple jurisdictions or some other element is involved over which the statewide prosecutor's office has jurisdiction. The statewide prosecutor can only prosecute theft claims under Ch.812 because violations under Ch.212 do not constitute predicate claims. Further, tax offenses are not currently considered RICO predicate offenses, which also deprives the statewide prosecutor's office of its most common jurisdictional tool.6
What the state investigators lack in technical training, they make up in tenacity. Typically, they arrive with a tape recorder, a statement of rights form and, occasionally, a second agent to conduct the interview. In Cash v. State, 609 So. 2d 1356, 1358 (Fla. 1st DCA 1992), the court recites the actions of the investigator, which experience has shown is their modus operandi. The investigator obtained a recorded statement without the taxpayer having obtained the advice of counsel. In the statement the taxpayer admitted he had signed the subject tax returns and, further, stated he had decided not to pay the taxes due. He was asked a series of leading questions establishing that he knew it was unlawful for him to convert the funds, as well as giving personal economic reasons as to why he had kept the taxes. Typically, this is accompanied by the surrender of relevant documents and, by the time the investigators leave, most, if not all, of the defenses of the taxpayer have been negated.
After the investigator reports his or her findings and recommendation, the report is review by the local supervisor. The local supervisor, in turn, forwards it to the deputy chief, who reviews and approves the recommendation which is then forwarded to the chief. Next, the chief reviews the case, and, in turn, refers it to the division director and to the staff attorney. Once they approve the case, it is referred to the local state attorney for prosecution. Unlike the federal tax system, in which a special agent conference, a district counsel conference, a Department of Justice conference and, finally, a U.S. attorney conference is made available to the taxpayer before indictment, there is no opportunity for the taxpayer to have input at any of these reviews except at the investigator stage. There may be a rare opportunity for such input under unusual circumstances.7 This author experienced one situation when he did meet with the bureau chief and the investigator prior to the matter going forward by making a specific request to do so.
The Department of Revenue has promulgated an internal management memorandum for case selection and assignment, and for criminal prosecution recommendations and referrals.8 The guidelines provides that it is only a policy and is not to be promulgated as a rule pursuant to F.S. § 120.54. However, all employees involved in the preparation and review of these cases must address the guidelines. They provide that cases will be assigned for investigation where these is a "reasonable good faith belief" that a criminal violation of tax law appears to be flagrant. The term "flagrant" is defined as existing where there is a preponderance of aggravating factors greater that the mitigating factors. The guidelines state the taxpayer's expressed attitude, whether friendly and cooperative or unfriendly and belligerent, will not be a determinative factor provided, however, that cooperation is considered a mitigating factor.
The guidelines then list the following factors:
1) Discovery of liability. This focuses on whether the taxpayer came forward voluntarily prior to discovery of the violation.
2) Nonpayment upon notice. The taxpayer did not make voluntary payment once notices were sent.
3) Attempts to collect. The department made a reasonable attempt to collect, but the taxpayer did not reasonably attempt to pay.
4) Amount of tax liability. There is to be a significant amount of tax liability, which is defined as generally exceeding $5,000.
5) Intentional delinquency. Although the taxpayer has registered, there is evidence that he or she is intentionally failing to file tax returns.
6) Non-registration (licensing). The taxpayer has intentionally failed to obtain a certificate of registration.
7) Concealment of assets. The taxpayer has attempted or has concealed or transferred assets to avoid enforcement or collection activity.
8) Falsified tax returns. The taxpayer has willfully filed a false return.
9) History of noncompliance. The taxpayer has a history of repeated noncompliance with filing requirements.
10) Other related criminal activity. The taxpayer is involved in other criminal activity involving fraud or other economic crime.
11) Workload. There are sufficient investigative resources to assign the case to criminal investigation personnel.
12) Targeted compliance projects. The taxpayer's violation is an example of a specific enforcement problem which has been targeted for criminal enforcement due to a reasonable good faith belief of criminal activity by some member of the targeted industry.
13) Refused cooperation. The taxpayer refused to comply with reasonable requests to provide records, tax returns, and asset information. The taxpayer may exercise his or her right against self-incrimination without impacting the decision to prosecute.
The guidelines then instruct that, using the list above, the bureau determine whether aggravating factors exceed mitigating factors. Once these factors have been reviewed, the guidelines provide that, in order to make a criminal prosecution recommendation and referral, the following must exist:
1) Probable cause. A case will be referred only after evidence establishes "probable cause" that a crime was committed. However, a referral without recommendation for prosecution can be made in order to obtain investigative assistance, such as issuance of subpoenas, search warrant applications, or legal advice.
2) Clear and convincing evidence. There must be clear and convincing evidence of a willful intent to evade taxes.
3) Intent or willfulness. Where intent is not specified as an element of a crime in the statute, it is the policy of the department that intent be included as a required element of proof.9 Generally, the department will prove the taxpayer a) had knowledge of the violation; b) had the ability and control to avoid committing the violation; and c) received some benefit from the violation.
4) Payment. Voluntary payment may be relevant to intent and willfulness, but will not preclude criminal prosecution.
5) Civil Remedies. The availability of civil enforcement options is not a factor in the decision to refer a case.
6) Mitigating Factors. If mitigating factors, such as age or health, have a direct effect on a taxpayer's capability to pay the tax, the will be taken into account.
While some of the guidelines are vague and ambiguous, there are certain conclusions that can be drawn. For example, it can be to the taxpayer's advantage to make voluntary disclosure. Further, if the liability exceeds $5,000, there is a greater likelihood that a taxpayer's case will be handled criminally. Also, a history of noncompliance will work against the taxpayer. Significantly, voluntary payment, by itself, may not prevent prosecution. Not withstanding the amount involved, if the violation is targeted under a specific compliance program, the risk of prosecution will be greatly increased. For example, the department has currently designated §212.085, the issuing of false re-sale certificates, primarily in Miami and Ft. Lauderdale areas, as a targeted compliance issues even those such cases usually involve amounts less than $5,000.
Finally, particularly flagrant acts may lead to prosecution. The failure to collect tax rarely would be pursued. But, in once case, a retail jeweler attempted to avoid collecting sales taxes by preparing sham invoices and sending empty boxes out of state in an attempt to make it appear that the merchandise had been sold to out-of-state purchasers. This flagrant activity resulted in prosecution, notwithstanding the relatively minor status assigned to it in the statutory scheme.
Knowledge of these guidelines is an important aid to practitioners evaluating the seriousness of their client's non compliance with Florida's sales tax laws. It can also be useful in arguing to the prosecuting authorities that the particular case at hand is contrary to their own policies. The guidelines also highlight the importance of clients immediately obtaining representation upon being contacted by an investigator before serious mistakes are committed. There is a joke among tax lawyers about receiving a phone call from a client who advises that criminal investigators have just left the client's office. The lawyer inquires, "What did you tell them?" to which the client responds, "Nothing." The lawyer then inquires, "How long were they there?" to which the client responds, "Two hours." It is not unusual to find that a client has turned over all his or her records, has discussed the matter in great detail with an investigator, has signed a statement of rights waiving his or her rights, and has submitted to a tape recording in which he or she has admitted culpability. It is equally important that the complete legal and factual background surrounding the taxpayer's business records and activities be fully explored, analyzed, and understood in light of the guidelines to determine whether the taxpayer is at risk and whether cooperation may be in the client's best interest.
1 From October to December 1992, Florida provided amnesty from criminal prosecution to those who reported taxes due and payable on or before June 1, 1992. See Fla. Laws ch.92-320.
2 Statistics provided by the Department of Revenue, Bureau of Enforcement, February 6, 1995.
3 Cash v. State, 629 So. 2d 1100 (Fla. 1993), held that the relationship of a dealer with the state is one of agent/principal and not debtor/creditor, thus permitting prosecution under the general theft statute.
4 Each tax period constitutes a separate violation so that a separate crime is chargeable for each distinct month that monies are not reported and paid. State v. H.M. Bowness Oil, Inc., 522 So. 2d 73 (Fla. 5th D.C.A. 1988); State v. Sun City Oil Company, Inc., 522 So. 2d 474 (Fla. 5th D.C.A. 1988)
5 Interview with David Skinner, chief, Bureau of Enforcement, Criminal Investigations on February 1, 1995.
6 FLA. STAT. § 895.02; State v. Sun City Oil Company, Inc., 522 So. 2d 73
7 Interview with David Skinner, chief, Bureau of Enforcement, Criminal Investigations on February 1, 1995.
8 Criminal Prosecution Policy of the Department of Revenue, International Management Memorandum.
9 This guideline may be based upon decisions in State v. Sun City Oil Company, Inc., and State v. H.M. Bowness Oil, Inc., in which the court read the element of criminal intent into the statute at issue.
This article published in The Florida Bar Journal, Volume LXIX, No. 11, December 1995,
Pages 71-74.
"I'm Liable For What?"
The IRS Trust Fund Penalty (IRC §6672) and How to Avoid It ©
by John G. DeLancett, Esq.
I. Section 6672 - The Trust Fund Penalty
A. IRC § 6672 provides that "Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable for a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over."
1. Usually applied to income tax withholding or social security tax, but can be applied to any other taxes required to be withheld or collected. The amount of tax collected or withheld by the employer is a special fund held in trust for the United States. IRC §7501 (a). (Hence, the "trust fund recovery penalty").
2. The employee receives credit for the withheld amounts and, therefore, the government may not receive payment unless it can collect under the provisions of the statute. Slodov v. United States , 436 U.S. 238, 243 (1978). Accordingly, §6672 is often interpreted as a collection device more than as an improper action on the part of the person against whom it is assessed. Caterino v. United States , 794 F. 2d 1 (1 st Cir. 1986).
3. It can also be applied where there was no withholding because of employer misclassification of workers as independent contractors. See In re: Smith, 99-1 USTC Para. 50, 10, 278 (Bank. D. Haw. 1999).
4. It is sometimes called the 100% penalty because it is equal to 100% of the tax withheld.
B. General Rules of Liability.
1. More than one person may be assessed the penalty. Turner v. United States , 423 F. 488 (9 th Cir. 1970).
2. All persons assessed the penalty are jointly and severally liable; that is, they are each liable for the full amount. Brown v. United States , 591 F. 2d 1136 (5 th Cir. 1979).
3. A right of contribution exists among those persons deemed liable for the penalty.
IRC § 6672(d)
4. Any payment made by an individual assessed for the trust fund penalty is not deductible for federal income tax purposes. Duncan v. Commissioner , 68 F. 3d 315 (9 th Cir. 1995).
5. A trust fund penalty assessment is not dischargeable in bankruptcy. 11 U.S.C. §507 (a) (8) (C).
6. Since a sole proprietor is directly liable for withheld federal income taxes and FICA taxes, the 100% penalty does not apply as it is superfluous. IRC § 3403; 3102(b)
7. If a state's partnership laws make all partners jointly and severally liable for debts of the partnership, the IRS may not be required to prove that a partner is liable under §6672, although that option remains.
8. There is no requirement that the IRS first collect from the employer before proceeding to collect against individuals. Hornsby v. Commissioner , 588 F. 2d 952 (5 th Cir. 1979); Hochstein v. United States , 900 F. 2 nd 543 (2 nd Cir. 1990).
II. Responsible Person
A. In the analysis as to whether there is liability under §6672, there are two major issues: a) responsible persons and b) willfulness.
1. A responsible person can be virtually anyone who controls the decision making
process as to which creditors are paid. This is sometimes referred to as the person having the final word or authority over financial affairs and the one ultimately responsible for non-payment of the trust fund taxes. In fact, the Service's position is that the low standard of conduct necessary to trigger responsible person liability is not based solely on the responsible person's conduct, but it is, in fact, a device to secure the collection of revenue rightfully due from the employer and is strictly an enforcement mechanism. See CM 200532046.
2. Expressions of the test for a responsible person run the gamut from whether you have the power to avoid a default in the payment of a tax to having ultimate authority to control the financial decisions to whether you have the power to compel or prohibit allocation of corporate funds.
B. Applying the tests to individuals.
1. Usually, the cases focus on the functional issue of whether the individual exercised control, especially over disbursement of funds and priority of payments. However, as will be seen below, sometimes the naked legal power to act is sufficient.
2. The government bears the burden of proving that the taxpayer is a responsible person; but, once this is established, the burden shifts to the taxpayer to prove that its failure was not willful. Mazo v. United States, 591 F. 2d 1151 (5 th Cir. 1979).
3. Usually, volunteers or unpaid members of any board of trustees or directors of tax exempt organizations will not be assessed, provided that they are solely serving in an honorary capacity. However, if the volunteer is involved in the financial operations or day to day conduct of business, they may still be deemed liable. Holmes v. United States , 2004-2 USTC Para. 50, 301 (S.D. Texas 2004).
4. Whether or not an individual is deemed to be responsible is a question of fact. Merchants National Bank of Mobile v. United States , 878 F. 2d 1382 (11 th Cir. 1989).
But, see Barnett v. Internal Revenue Service , 988 F. 2d 1449 (5 th Cir. 1993) (where an individual won a jury verdict but was reversed on appeal because the issue of responsibility was held to be a matter of law).
5. Liability for the collection of trust fund taxes arises when the taxes are paid, that is withheld, not when the return is due. Therefore, resigning prior to the due date of the return will not avoid liability. Kalb v. United States , 505 F. 2d 506 (2d Cir. 1974).
6. Check writing authority is often an important indication that a person is a responsible party. However, the mere mechanical duty of signing checks does not, in and of itself, impose liability where there is no actual control over the organization's funds. Werner v. United States , 374 F. Supp. 558 (D. Conn. 1974); Vinick v. United States , 205 F. 3d 1 (1 st Cir. 2000); Williams v. U.S. , 931 F. 2d 805 (11 th Cir. 1991).
7. A frightening aspect of §6672 is that an individual may be a responsible person if he merely had the authority to exercise significant control over financial affairs regardless of whether he, in fact, exercised that control. In re: Marino, 311 B. R. 111 (M.D. Florida 2004); Schlicht v. United States , No. CIV-05-1606 (D. Az. 2005); Hartman v. U.S. , 532 F. 2d 1336 (8 th Cir. 1976).
8. Typically, the penalty will be assessed against officers, directors and shareholders of a corporation, if they exercise significant control over the corporation's financial affairs. Merely holding an official title does not necessarily render the individual a responsible person. Winter v. United States , 99-2 USTC Par. 50, 955 (2nd Cir. Nov. 8, 1999); 26 U. S. C. A. §6671 (b). On the other hand, not holding an official title does not necessarily mean an individual will not be classified as a responsible person if they had the requisite control. Stuart v. United States , 337 F. 3d 31 (1 st Cir. 2003).
9. In one case an individual was held responsible because he arranged or guaranteed loans for a business and, upon the general manager's abandonment of the company, assumed the responsibility of mailing and signing the tax returns. Caterino v. United States , 794 F. 2d 1 (1 st Cir. 1986).
10. Even employees of lenders have been held to be responsible persons as well as a surety, the surety's agent, lawyers, accountants, creditors, trustees, or fiduciaries.
11. A revenue officer is the individual who makes the initial determination of liability. This is typically done through interviews and review of documents obtained from the business. Internal Revenue Manual 5.7.3.3 sets out how a responsible person may be established. See excerpts attached as Exhibit "A".
12. Liability cannot be escaped by showing that the collecting and paying of the taxes has been delegated to a subordinate. Likewise, abdication of responsibility by a subordinate on the ground that the person was ordered, at the risk of losing their job, not to pay withheld funds has been rejected as a defense to the penalty. This is commonly referred to as the Nuremberg defense. See Roth v. United States ,779 F. 2d 1567 (11 th Cir. 1986); Howard v. United States , 711 F. 2d 729 734-735 (5 th Cir. 1983).
13. Interestingly enough, the IRS has issued a policy statement, P-5-60 (2-2-93) which states that, if you lack any independent authority to make decisions and are acting under the dominion and control of others, you should not be a responsible person. However, the cases do not seem to necessarily follow this policy.
14. Factors that have been considered in the cases include: (a) corporate bylaws setting forth duties of officers and directors, (b) ownership interests in the business, (c) status as an officer or director, (d) signature authority over the account, Williams v. United States , 931 F. 2d 805 (11 th Cir. 1991), (e) actual day to day management of a business, (f) hiring and firing employees, George v. United States , 819 F. 2d 1008 (11 th Cir. 1987), (g) authority to sign and file the payroll tax return and (h) unexercised authority, Tscuprake v. United States , 92-1 USTC Para. 50,429 (D. Fla. 1992).
III. Willfulness
A. Willfulness is a voluntary, conscious and intentional decision to pay other creditors instead of the United States.
1. Perhaps the best definition of willfulness is in United States v. Macagnone , 86 AFTR 2d Para. 5307 (M.D. Fla. 2000): willfulness means merely that the responsible person had knowledge of the tax delinquency and knowingly failed to rectify it when there were available funds to pay the government.
2. This requires knowledge that the taxes are due and have not been paid. A previously unaware person that becomes aware that taxes have gone unpaid can become a responsible person if he does not then make all efforts to pay the back taxes. Thosteson v. United States , 304 F. 3d 1312 (11 th Cir. 2002).
3. Even if no creditors are preferred, if the employer pays employees on a net payroll basis, that is; does not pay the payroll taxes and other costs associated with payroll, there can be liability.
4. There is no requirement that there be a bad motive or specific intent to defraud the government. United States v. Beltran , 316 BR 371 (S.D. Fla. 2004)
5. Mere negligence or a bonafide mistake does not constitute willfulness. Winter v. United States , 196 F. 3d 339 (2 nd Cir. 1999).
6. The Eleventh Circuit has held that where one acts with reckless disregard and has actual knowledge of previous delinquencies, so as to establish a known or obvious risk that the taxes are not currently being paid, can be deemed liable. Malloy v. United States , 17 F. 3d 329 (11 th Cir. 1994); Rife v. United States , 809 F. 2d 425, 427 (7 th Cir. 1987); In re: Frye, 91 B.R. 69, 70 (Bankr. E.D. Ms. 1988).
B. If there are no unencumbered funds to pay the taxes; i.e., the funds are subject to legal obligations by law, then the failure to use those funds will not render a person willful. Huizinga v. United States , 68 F. 3d 139 (6 th Cir. 1995).
C. Some circuits have recognized a reasonable cause defense with regard to the
issue of willfulness. Unfortunately, the Eleventh Circuit has not yet joined that group
IV. Procedures for Assessment and Enforcement
A. Statute of Limitations
1. IRC §6501 (a) imposes a general 3 year statute of limitations from the date the return is filed. If the return is false or fraudulent or if the return is not filed, the tax may be assessed at any time.
2. For purposes of §6672, the 3 year period begins to run from the April 15 following the date that the employer's return (Form 941) is due. For example if the return is for the second quarter of 2007, the statute of limitations would begin to run on April 15, 2008 and would expire, if the returns were timely filed, on April 15, 2011. The Service has taken the position that if the return is not filed, or is false or fraudulent, then the statute of limitations is likewise extended against a responsible party. See CM 2005 32046.
3. You may be asked to waive the statute of limitations. You should not do this unless you absolutely are convinced that you can document the fact that you will not be liable. The revenue agent has to make a decision concerning the trust fund recovery penalty no later than six months after receipt of the taxpayer delinquency account. It can be extended to one year, but no more than one year.
B. Required Notice. - IRC §6672 (b) provides that the Internal Revenue Service must send a notice of proposed assessment to any individual against whom it intends to assess the trust fund recovery penalty.
1. The taxpayer has 60 days from the date on the notice (75 days if outside the United States) to protest the proposed penalty assessment and to request an appeals conference. One consideration for protesting the penalty is that it prevents the accrual of interest. See CA 200235028.
2. If the taxpayer fails to appeal the proposed assessment within the time period the penalty will be assessed. Rev. Proc. 2005-34
3. If an appeal is taken, then the statute of limitations for assessment is extended for 30 days after the Service makes a final determination on the appeal. In other words, the statute of limitations is suspended for the length of time of the appeal plus 30 days.
4. If the appeal is rejected, the taxpayer must follow refund procedures. The United States Tax Court has no power to review the decision. Moore v. Commissioner , 114 T.C. 171 (2000).
C. Once the penalty has been assessed the IRS has ten years to collect it. IRC § 6502 (a)
D. Refund Litigation
1. A procedure applicable to the trust fund penalty provides thatcollection will be suspended if the responsible person pays the tax attributable to one employee for each taxable period at issue (each calendar quarter) within 30 days of the receipt of notice and demand for payment. After making this payment, the person must file a claim for refund and post a bond equal to one and a half times the total penalty assessed against him. IRC 6672 (c).
2. If the refund is denied or the IRS fails to act on the refund claim within a six month period, the person then has 30 days to initiate a refund suit in the United States District Court or the United States Court of Claims.
3. Since only issues raised in the claim for refund or in the appeal are subject to judicial review, it is critical that an attorney be involved in the preparation of those documents.
4. The statute of limitations for collection is suspended while the proceeding is in court.
E. It is important that these procedures be considered and followed because the tax is not dischargeable in bankruptcy. Rife v. United States , 809 F. 2d 425, 427 (7 th Cir. 1987); In re: Frye, 91 B.R. 69, 70 (Bankr. E.D. Ms. 1988).
V. How To Avoid the Trust Fund Penalty
A. Responsible Party Issues Before the IRS Appears
1. If you're not actually going to have control over the decision as to who gets paid, do not allow yourself to be put as a signor on the business checking account or to sign payroll tax returns or other activities relating to the payroll tax.
2. If you're involved in the bill paying process, submit a written list of the bills to be paid with a place to be initialed by the individual making the decision, so as to document who actually decided what bills were to be paid and when.
3. If there are individuals working for your business that are being classified as independent contractors, you may want to revisit that issue. If these individuals are reclassified by the IRS, you may be personally liable for the taxes that were not withheld.
4. Try to make it clear to employees and third parties that you do not have the final decision over who gets paid. Do not let your ego get in the way of avoiding potential liability.
B. Responsible Party Issues After the IRS Appears
1. Try to establish that you were not a responsible person at the time that the taxes were withheld; for example you had already left the employment or your position in the company had changed.
2. Establish that you did not have the authority to act. See, for example United States v. Stanton , 87 AFTR 2d Para 76-1427 (S.D. Fla. 1976). The corporation's vice president was only a foreman and had no control or participation in business or financial decisions.
3. Part of the agent's activities will be the interview of officers, employees and, possibly, even creditors of the corporation. These individuals should be identified and affidavits obtained from them, to the extent that they will support your position, that you are not a responsible person, or that you had no knowledge.
4. Other things to consider are minutes of the meetings of the board of directors and shareholders relating to authority and duties of officers and directors, payment of taxes, creditors and so forth.
5. Please note that, if you are under consideration as a responsible party, the Service conducts a full compliance check. Accordingly, if you've not filed your other returns, hang on to your seat, because they will be coming after you for that as well.
C. Potential Defenses as to Willfulness
1. Try to establish that your actions were simply negligent and not knowing or
intentional.
2. Try to establish that there were no funds or no unencumbered funds available to pay the taxes at the time that the responsible person first became aware of the non-payment of taxes.
3. Depending on where you live, try to establish a reasonable cause defense. While this has not been officially recognized by many circuits, some circuits have recognized it in theory, although, few have applied it in reality.
4. Misclassification of workers as independent contractors- if you can establish that you honestly believed that they were properly classified, this could establish a lack of willfulness. Kraut Management Services v. United States , 889 F. Supp. 1313 (D. Ore.1995).
D. Dealing with the Agent
1. The agent will try to interview you in person. Internal Revenue Manual 5.7.4.2.1. If at all possible, try to avoid being interviewed by the agent. If this is not possible, do a mock interview before going before the agent.
2. One of the most critical documents that will be involved in an investigation is Form-4180, "Report of Interview with Individual Relative to Trust Fund Recovery Penalty." See Exhibit "B" attached hereto.
a. This form is a series of questions that are asked during the revenue officer's interview. The responses are written down by the revenue officer and then the individual is asked to sign the form at the completion of the interview.
b. It is absolutely critical that you obtain a copy of this form, review it in detail and consult with a tax professional concerning your responses. Each of these questions is designed to establish your liability and a failure to carefully consider your responses could result in an assessment of the trust fund penalty.
c. The author has been involved in cases where the tentatively responsible person, prior to obtaining proper representation, signed a Form 4180 which contained an incorrect statement because of his lack of understanding of the question. Later, during an appeal, the appeals officer went back to the original statements contained in the Form 4180 and pointed to it as being more credible since it was given earlier in the process. As a result, the taxpayer lost his case.
E. Calculate the Statute of Limitations
1. It is possible that some of them may have run, or are about to run.
2. This may impact various tactical decisions throughout the process.
F. If any payments are to be made by the business, try to have them designated as payments to be applied against the trust fund portion of the assessment.
1. This may be difficult, but, the effort should always be made.
2. Otherwise the Service will apply it to the best interests of the Service and will apply it to the non-trust fund portion of the tax liability and other penalties and interests being assessed on that non-trust fund liability.
G. Always protest the proposed assessment.
1. Even if you can't get completely out of the assessment, you may be able to reduce the amount based on the computation of the tax or prevent an assessment for some of the periods.
2. In doing so, try to secure a copy of the file, including the trust fund computation sheets. The items requested should include Form 4180, Form 4183 (interview of the employer) and any documentary evidence gathered by the Service. If the IRS won't voluntarily give them to you, consider a Freedom of Information and Privacy Act request.
H. Try to establish that someone else is the responsible person.
1. This is particularly valuable if you can demonstrate that that individual has significant assets with which to pay the liability, or, sometimes even better, that he has removed assets from the business that could have been used to pay the liability.
2. While there can be more than one responsible party, if the "more responsible party" has significant assets, the Service may pursue him to the exclusion of others. The Service is known to "follow the money".
I. If your financial circumstances will support it, establish that you do not have the ability to pay the tax even if the Service were to assess you. The Service will not normally assert the penalty against an individual who has no ability to pay. Internal Revenue Manual 5.7.5.1.
J. Ultimately, if you are assessed, remember that you have a right to contribution from the other responsible parties.
1. You are entitled to request that the IRS disclose to you the name of any other person determined to be liable under §6672.
2. The IRS must also disclose what steps it has taken to collect from that person and the nature of the collection actions taken and the amounts, if any, received. IRC §6103 (e) 9.
VI. Conclusion
A potential §6672 assessment can be a total surprise and financially devastating.
Know the rules of the game and avoid this disaster.