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Responsible Person and Lender Liability for Trust Fund Taxes — Sections 6672 and 3505 (Portfolio 639)

Tax Management Portfolio, Responsible Person and Lender Liability for Trust Fund Taxes — §§6672 and 3505, No. 639-3rd, discusses in detail the liability of responsible persons under §6672 and of lenders and others who provide funds under §3505 where there is a failure of an employer to remit trust fund taxes to the government.

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Tax Management Portfolio, Responsible Person and Lender Liability for Trust Fund Taxes — §§6672 and 3505, No. 639-3rd, discusses in detail the liability of responsible persons under §6672 and of lenders and others who provide funds under §3505 where there is a failure of an employer to remit trust fund taxes to the government.


Section 6672, often referred to as the “100% penalty” or the trust fund recovery penalty, subjects those persons considered responsible for the collection and payment of withholding taxes to personal liability where the employer fails to pay over such taxes to the government. Although technically a penalty provision, §6672 is used solely as a device to collect the amount of unpaid taxes, not as a means of imposing an additional penalty over and above such amount. Liability attaches under §6672 only when the individual is classified as a “responsible person” and the actions are considered “willful.”


Section 3505 subjects two main categories of persons to liability. First, §3505(a) applies to those who pay wages directly to employees of another employer, or to an agent on behalf of such employees. Liability in this case is the total amount of the unpaid taxes. Second, §3505(b) is directed at those lenders, sureties, or others who specifically finance payrolls, although not paying employees directly. Liability is not imposed upon these persons under §3505(b) unless they provide funds specifically for payrolls and have actual notice or knowledge that the employer does not intend to or will not be able to make timely payment of the withholding taxes. Liability under §3505(b) is limited to 25% of the financing provided for net payroll.


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AUTHORS

JUAN F. VASQUEZ, JR.
Juan F. Vasquez, Jr., J.D. (B.B.A., University of Texas; J.D., University of Houston Law Center, 2001; LL.M. Taxation, New York University, 2002). Juan is a Shareholder in the Tax Controversy Section of Chamberlain, Hrdlicka, White, Williams and Martin. In addition to his tax controversy practice, Juan also advises clients in the areas of general tax and business planning and serves as an Adjunct Professor at the University of Houston Law Center, where he teaches Tax Controversy & Litigation and Taxation of Sales & Exchanges.
Juan is named as a leading individual in the Tax Litigation Nationwide category in the Chambers USA's “America's Leading Lawyers for Business” Client Guide, is named in The Best Lawyers in America in the specialty of Tax Law, and is named a “Texas Rising Star” by Texas Monthly. Juan is a recipient of the American Bar Association Tax Section's Pro Bono Award and Nolan Fellowship.
Juan serves as Past Chair of the Houston Bar Association Section of Taxation, Chair of the Diversity Committee of the American Bar Association Section of Taxation, Chair of the Privilege and Evidence Subcommittee of the Committee on Court Procedure & Practice of the American Bar Association Section of Taxation, Past President of the Mexican American Bar Association of Houston, Vice President of the Hispanic Bar Association of Houston, Past Chair of the IRS Tax Practitioner Study Group of Houston, Director on the Board of Directors and member of the Executive Committee for Big Brothers Big Sisters of Greater Houston, Chairman of the Audit Committee for Big Brothers Big Sisters of Greater Houston, and as a member of the Board of Directors of the Houston Business and Tax Law Journal.
Juan has delivered presentations before the American Bar Association Section of Taxation, IRS Nationwide Tax Forum, Tax Executives Institute, Inc., Houston Bar Association Tax Section, and the Houston Bar Association. He is also a frequent lecturer and author on topics relating to tax procedure, partnerships, corporate tax, and related controversies. Juan has published articles appearing in the Houston Business and Tax Law Journal, Journal of Taxation, Journal of Tax Practice & Procedure, The Tax Lawyer, Tax Analysts Tax Notes, State Tax Notes, The Texas Tax Lawyer, Texas Bar Journal and The Monthly Digest of Tax Articles.

PETER A. LOWY
Peter A. Lowy (J.D., Tulane Law School; L.L.M. Taxation, New York University School of Law). Lowy is a member of the New York and Texas bars, and specializes in tax controversies. Lowy graduated from New York University School of Law where he received his LLM in Taxation, and Tulane University School of Law where he received his JD and was on the Tulane Law Review.
After law school, Lowy clerked for a U.S. District Court and for the U.S. Tax Court. Lowy is currently Senior Tax Counsel for Shell Oil Company where he specializes in tax controversies. Lowy also serves as an Adjunct Professor at the University of Houston Law Center, where he teaches Tax Controversies & Litigation and Tax Research. Active in the American Bar Association, Lowy chairs the Tax Section's Pro Bono Committee and vice-chairs the Court Procedure & Practice Committee.
Lowy is the author of 100 T.M., U.S. Federal Tax Research (2005), and a contributing editor to Effectively Representing Your Client Before the IRS, 4th Edition (2008), published by the American Bar Association Tax Section. Lowy is a recipient of the American Bar Association Tax Section's Pro Bono Award and Nolan Fellowship.

TABLE OF CONTENTS

Detailed Analysis

I. Section 6672

A. In General

B. Type of Taxes to Which § 6672 Applies

C. Section 6672 and Independent Contractors

D. Function as IRS Collection Device

1. Collection in Lieu of Taxes

2. No Requirement to Collect from Employer First

E. Definition of Responsible Person

1. In General

2. Definition of Person

3. Identifying Responsible Person

a. In General

b. Specific Factors

(1) Contents of Corporate Bylaws

(2) Stock Ownership

(3) Holder of Corporate Office

(4) Corporate Director

(5) Authority to Sign Checks

(6) Day-to-Day Management

(7) Hiring and Firing Employees

(8) Authority to Sign and File Tax Returns

4. Unexercised Authority

5. Disjunctive Reading of Statute - Scope of § 6672 Not Limited Only to Those Persons Performing All Three Statutory Duties

6. Multiple Responsible Persons

7. Volunteers of Charitable Organizations

8. Sole Proprietors

9. Partners

10. Bookkeepers

11. Employee Leasing Arrangements

12. Liability of Those Outside Formal Structure of Business

13. Effect of Family Relationships

14. Knowledge of Trust Fund Tax Liability

15. Mere Technical Authority or Titular Designation

F. Willfulness Required

1. In General

2. Definition of Willfully

3. Financial Difficulties of Corporation

4. Inadequate Funds to Pay Gross Wages

5. Failure to Pay Over Pursuant to Superior's Order

6. Lack of Knowledge of Unpaid Taxes

a. Responsible Persons During Accrual of Delinquency

b. Responsible Persons After the Delinquency

c. Definition of Unencumbered Funds

7. Coercion by Creditors

8. Reckless Disregard of Obvious or Known Risks That Taxes Are Not Being Paid

9. Investigate-or-Correct Mismanagement Rule

10. Negligence, Confusion or Mistaken Belief Leading to Unpaid Trust Fund Taxes

11. Comparison to Criminal Standard

12. Reasonable Cause

13. Coordination of § § 3509 and 6672 as They Relate to Willfulness

G. Sale of Company

1. Seller of Business

2. Purchaser of Business

H. Amount of Liability

1. Limited to Withheld or Collected Portion

2. Time Liability Attaches

3. Interest and Penalties

4. Knowledge of Deficiency Subsequent to Failure to Pay Taxes; After-Acquired Funds

5. Responsible Person Status Attained Subsequent to Failure to Pay Taxes

I. Summary of Commonly Raised Defenses

1. Lack of Sufficient Authority

2. Resignation

3. Lack of Knowledge

4. Delegation of Authority

a. Responsible Person Status

b. Willfulness

5. Directions From Others

6. Final Word

7. Defending the Subordinate Employee

8. Reasonable Cause

9. Equitable Defense Where Government's Conduct Prevents Collection of Trust Fund Taxes

10. Statute of Limitations

11. Previous Negotiations with IRS

12. Alcoholism, Drug Addiction and Physical Illness

13. Section 3509 Relief for Employer Negates Willfulness Under § 6672

J. Collection or Satisfaction of and Contribution for Penalty

1. Joint and Several Liability

2. Disclosure of IRS Collection Efforts Against Others

3. Right of Contribution or Indemnity from Others

a. From Other Responsible Persons

(1) Federal Law

(2) State Law

b. From the Employer

4. No Requirement to Collect From Employer First

5. Satisfaction by Employer as Satisfaction Against Responsible Person

6. Satisfaction by One Responsible Person as Satisfaction Against Another Responsible Person

7. Satisfaction by Responsible Person as Satisfaction Against Employer

K. Allocation of Payments to Trust Fund Taxes

1. Generally

2. Voluntary Payments

3. Oral Agreements to Designate Payments to Trust Fund Taxes

4. Designation May Be Implied

5. Involuntary or Undesignated Payments

6. Standard to Determine Voluntary Payments

7. Tax Payments Made in Bankruptcy

8. IRS's Ability to Reallocate Undesignated or Involuntary Payments

L. Bankruptcy Aspects

1. Corporate Bankruptcy

a. Effect on Liability of Responsible Person

b. Allocation of Payments to Trust Fund Tax Liability

(1) Chapter 11 Reorganization and Liquidation

(2) Chapter 7 Liquidation

c. Trust Fund Tax Payments Made Within 90-Day Pre-Petition Period

2. Responsible Person's Bankruptcy

M. Statute of Limitations

1. Assessment

2. Notice Requirement Prior to Assessment

3. Collection

4. Effect of Bankruptcy

5. Criminal Statute of Limitations

N. Deductibility of Payments Under § 6672

1. Business Deduction Under § 162

2. Bad Debt Deduction for Payment of Penalty

3. Loan of Trust Fund Taxes to the Employer

4. Contribution of Trust Fund Taxes to Capital

5. Deductibility of Accrued Interest on the Trust Fund Recovery Penalty

O. Procedure

1. Investigation by Revenue Officer

2. Appeal Rights

3. Assessment

a. In General

b. Presumption of Correctness

c. Jeopardy and Quick Assessments

d. Accrual of Interest

e. Procedure in Repeat Offender Cases

4. Claim for Refund

a. In General

b. Statute of Limitations

c. Divisible Tax

d. Stay on Collection Activity

(1) Rules for Tax Attributable to Taxable Periods Ending On or Before December 31, 1998

(2) Rules for Tax Attributable to Taxable Periods Beginning After December 31, 1998

5. Multiple Responsible Persons

a. Contesting the Assessment

b. Collection Issues

c. Refund Suits

d. Rights to Obtain Information About and Recover From Other Persons

6. Standards of Appellate Review

a. Issue of Responsibility

b. Issue of Willfulness

II. Section 3505 - Liability of Third Parties Paying or Providing for Wages

A. Background

B. Definition of “Other Person” in § 3505

1. In General

2. Agents and Conduits

3. Contractors

4. Shareholders

C. Direct Payment of Wages by Third Parties - § 3505(a)

1. Amount and Nature of Liability

a. Tax and Interest

b. Penalties

2. What Constitutes Direct Payment of Wages?

a. Timing of Payment Unimportant

b. Control of Funds May Establish Direct Payment

D. Supplying Funds for Wages - § 3505(b)

1. Supplying Funds

a. Honoring Overdrafts

b. Same Day Availability of Deposited Funds

c. Shareholder/Guarantor

d. Providing Funds as Agent of Other Suppliers

e. Control Over Funds Equivalent to Supplying Funds

2. Supplying Funds for the Specific Purpose of Paying Wages

a. Definition of Ordinary Working Capital Loan

b. Actual Notice/Knowledge that Funds Will Be Used To Pay Net Wages

c. Supplier Need Not Know Exact Amount Used

d. Tracing the Portion of Funds Provided for Wages

e. Providing Sufficient Funds for Gross Wages Does Not Always Negate Purpose of Providing Funds for Net Wages

f. Control of Employer's Funds May Establish Purpose of Loan

g. Summary

3. Notice or Knowledge of Nonpayment

4. Limiting Lender Liability Under § 3505

5. The 25% Limitation on § 3505(b) Liability

a. Calculation of the 25%

b. Does the 25% Include Interest?

E. Liability of a Debtor of the Employer Under § 3505

F. Procedural Aspects of § 3505

1. Voluntary Payment of Liability

2. Assessment and Enforcement of Liability

a. Necessity of a Civil Proceeding

b. Notice of Assessment Not Required

c. When Statute of Limitations Begins to Run on a Civil Proceeding

III. Comparison of Remedies Under Sections 6672 and 3505

A. Overview

B. Sections 6672 and 3505(a)

C. Sections 6672 and 3505(b)

D. Deductibility of Payments

E. Credits Between Sections

IV. Relationship Between Section 6672 and Section 6663 Fraud Penalty

V. Personal Liability for Unpaid Diesel, Gasoline, and Fuel Excise Taxes

VI. Criminal Sanctions for Failure to Pay Withholding Taxes


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Sample IRS Letter Accompanying Form 2751

Worksheet 2 Procedures Providing Certain Conditions Under Which Third Parties Financing Employers' Payrolls Are Liable for the Taxes Required to Be Withheld from Employees' Wages. [Rev. Proc. 78–13, 1978–1 C.B. 591]

Worksheet 3 Procedures for Appeals of Trust Fund Recovery Penalty Assessments Under Section 6672 [Rev. Proc. 2005-34, 2005-24 I.R.B. 1233]

Worksheet 4 IRS Policy Statement P–5–60: Trust Fund Recovery Penalty

Worksheet 5 Internal Revenue Manual Excerpts - Trust Fund Compliance [IRM 5.7]

Worksheet 6 Chart: Comparison of Employment Tax Liability of Employer, Responsible Persons, and Parties Subject to Section 3505(a) and Section 3505(b).

Worksheet 7 Sample Complaint for Refund of Section 6672 Taxes (U.S. District Court).

Bibliography

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Statutes:

Treasury Regulations:

Committee Reports:

Treasury Rulings:

Cases:

UNOFFICIAL

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