Wednesday, October 3, 2012

Trust Fund Recovery Penalty (TFRP) Procedures (10/3/12)

In the UH Tax Procedure Class we will spend a good bit of time on the Trust Fund Recovery Penalty ("TFRP"), Section 6672, here.  That penalty is also called the responsible person penalty for reasons that will become obvious.  I write today to advise readers of the audit and assessment process that is covered only cryptically in the course and in my Federal Tax Procedure book.  First, I introduce the TFRP by cutting and pasting the introduction to the subject in my Federal Tax Procedure Book (footnotes omitted):
Trust Fund Recovery Penalty (TFRP) - § 6672. 
The Internal Revenue Code requires employers to withhold social security and federal excise taxes from their employees' wages. The employer holds these monies in trust for the United States.§ 7501(a). Accordingly, courts often refer to the withheld amounts as “trust fund taxes”; these monies exist for the exclusive use of the government, not the employer. Payment of these trust fund taxes is not excused merely because as a matter of sound business judgment, the money was paid to suppliers in order to keep the corporation operating as a going concern – the government cannot be made an unwilling partner in a floundering business. 
The Code assures compliance by the employer with its obligation to pay trust fund taxes by imposing personal liability on officers or agents of the employer responsible for the employer's decisions regarding withholding and payment of the taxes. Slodov v. United States, 436 U.S. 238  (1978).   To that end, § 6672(a) of the Code provides that “[a]ny person required to collect, truthfully account for, and pay over any tax . . . who willfully fails” to do so shall be personally liable for “a penalty equal to the total amount of the tax evaded, or not . . . paid over.” § 6672(a). Although labeled as a “penalty," § 6672 does not actually punish; rather, it brings to the government only the same amount to which it was entitled by way of the tax.  
Personal liability for a corporation's trust fund taxes extends to any person who (1) is "responsible" for collection and payment of those taxes, and (2) "willfully fail[s]" to see that the taxes are paid.
The phenomenon often giving rise to the penalty is that the employer becomes delinquent in turning over the trust fund taxes to the IRS and then is unable to pay them.  Frequently when a business is experiencing cash flow difficulties, the principal person or persons managing the business will attempt to keep the business afloat by using the trust fund taxes to pay what he or they perceive as more demanding needs; usually the expectation is the cash flow shortfall will be resolved, so that the trust fund tax will be paid later.  The withholding taxpayer (the employer in the case of employment taxes) will often view its interim use of the trust fund tax proceeds as only a temporary expedient to get past the rough spots, with every intention of ultimately paying.  If the business succeeds or the withholding taxpayer otherwise pays the delinquent taxes (with interest on the delinquent payments), everything works out fine.  Too often, however, the business goes under, with the IRS (as well as many other creditors) holding the bag because, as noted, the IRS must give the taxpayer-employee credit for the withheld amount just as if the IRS had received it. 
Section 6672 imposes civil liability – the TFRP – for the unpaid trust fund taxes upon those persons who organizationally had the responsibility and power to insure that the withheld taxes were paid over to the Government for the trust fund taxes rather than being used for other purposes.  The person(s) subject to the TFRP are those persons (1) who were “required to collect, truthfully account for, and pay over” and (2) who willfully failed to do so.  The statute refers to the liability as a penalty but in reality it is just a secondary tax collection mechanism if the employer fails to remit the withheld taxes to the Government.
With that introduction, I refer readers to the following article:  Seth Kossman, A Trust Fund Recovery Penalty Primer (AICPA 10/1/12), here.  I recommend Mr. Kossman's article to those interested in this area.  The part of the article I draw readers' particular attention to is:
The TFRP Assessment Process 
* * * * 
Prior to making a recommendation regarding a responsible and willful individual, the revenue officer must secure core documentation necessary to support the recommendation for each quarter being assessed. The necessary core documents include the articles of incorporation; bank signature cards or electronic PINs/passwords; and a sampling of canceled checks demonstrating payment to other creditors in preference to the government or, if the taxpayer predominantly uses electronic banking, bank statements demonstrating debit transaction payments to other creditors in preference to the government. If the revenue officer cannot secure all of the core documentation, he or she must record why the documentation was inaccessible and why the missing documentation was not necessary to support the recommendation. 
Generally, the revenue officer interviews the individuals whom the preliminary investigation identified as potentially responsible and willful. The revenue officer uses Form 4180, Report of Interview With Individual Relative to Trust Fund Recovery Penalty or Personal Liability for Excise Taxes, in the interview to record detailed information about the business. The revenue officer asks detailed questions about the individual’s role in the business and other individuals associated with the business. This means that the IRS will ask people to inform against their superiors and co-workers. 
Form 4180 is evidence and, as such, needs to be taken very seriously. The individual’s representative should ensure that the revenue officer accurately and completely records the answers given. Individuals may provide the revenue officer with affidavits from other company personnel to supplement the individual’s testimony. Many of the questions on Form 4180 do not give room for explanation, and affidavits from other employees can be invaluable tools to supplement the “yes” or “no” answers on the form and give the revenue officer a complete picture. Additionally, affidavits help lay the groundwork if the case is forwarded to IRS Appeals. 
The revenue officer may request that the potentially responsible individual complete a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, to determine potential collectability. However, the revenue officer may not have authority to insist on the form’s completion unless there are already other assessments against the individual. If a successful collection from the responsible party is unlikely, either because there is no present or future collection potential or the responsible person and his or her assets cannot be located, the IRS generally will not assess the TFRP against that individual.\ 
The actual collection of the TFRP begins with Letter 1153(DO) and Form 2751, Proposed Assessment of Trust Fund Recovery Penalty, notifying the individual that there will soon be a demand for payment of the TFRP. The individual usually has the right to appeal the proposed TFRP assessment for 60 days after the date of Letter 1153(DO). Unless the individual agrees with the revenue officer’s determination and agrees to the assessment, it is advisable to file a written protest with the revenue officer. The protest should contain the individual’s name, address, and Social Security number; a copy of the Letter 1153(DO); a request for an appeal conference; the tax periods involved; and a list of issues being contended, including citations to the legal authorities that support the protest. 
Generally, assuming Forms 941, Employer’s Quarterly Federal Tax Return, or comparable returns were timely filed, the IRS has three years to assess the TFRP from the April 15 that succeeded the return’s due date (IRM § If the business’s return was filed after the due date, the statute of limitation begins to run from either the April 15 that succeeded the return’s due date or three years from when the return was actually filed, whichever is later. However, false or fraudulent returns and returns prepared by the IRS under Sec. 6020(b)(1) do not start the running of the statute. 
The individual against whom the TFRP is assessed should note that the IRS applies payments in its best interest. This means that the IRS first applies a payment made from business assets to the non–trust fund portion of a company’s tax liabilities, and only after that liability is satisfied does the IRS apply payments to the trust fund portion of the taxes. By following certain procedures, taxpayers generally can designate that the IRS apply the voluntary payments toward the trust fund taxes only. If the individual pays the assessed TFRP but does not agree with the assessment, he or she can then file a Form 843, Claim for Refund and Request for Abatement. A responsible person cannot file a refund suit until six months after the refund claim is filed unless the IRS denies the claim within six months. If the IRS denies the claim, the individual generally has two years to file a refund suit in U.S. district court. 


Form 4180, Report of Interview with Individual Relative to Trust Fund Recovery Penalty or Personal Liability for Excise Taxes, here.

Howard S. Levy, IRS Trust Fund Investigations: The Best Defense Is a Good Offense (AccountingWeb 3/31/10), here.

Finally, for those wanting to consider other resources, I have pasted below the excerpts from the table of contents related to the discussion of the TFRP in my Federal Tax Procedure Book and and the entire concluding section titled "Summary":

B. Liability for Trust Fund Taxes.
1. Introduction.
a. Withholding Taxes a/k/a Trust Fund Taxes.
b. Trust Fund Recovery Penalty (TFRP) - § 6672.
2. Elements of Liability.
a. Parsing the Elements of the Statute.
b. Gravamen - Control of Financial Decisions.
c. Willfulness.
d. Reasonable Cause.
e. Exception for Unpaid Volunteers to Charities.
3. Administrative Procedures.
a. Audits and Appeals.
b. Assessments and Predicates.
c. Statute of Limitations.
4. IRS Policy to Collect Only Once.
5. Collection Due Process.
6. Litigating the TFRP.
a. The Traditional Procedure - The Refund Suit.
(1) Procedural Predicates.
(2) The Litigation.
(3) Counterclaims and Other Parties.
b. The CDP Alternative Procedure.
7. Bankruptcy and the TFRP.
8. Planning for the TFRP.
9. Contribution Among Responsible Persons.
10. Summary.

From the Federal Tax Procedure Book (all of the following is from the book but I do not indent anything except the excerpt from the opinion quoted):

10. Summary.

Some important facets of the TFRP are discussed in Judge Posner's opinion in Mortenson v. National Union Fire Insurance Co., 240 F.3d 677 (7th Cir. 2001).  In that case, the plaintiff sought recovery of the TFRP under a directors and officers (“D&O”) liability insurance policy which insures directors and officers against liabilities arising from their conduct as directors and officers.  As is usual in such policies, penalties were excluded.  The question presented was whether the TFRP was a penalty.  Judge Posner concludes that the TFRP is indeed a penalty at least for insurance purposes; his reasoning includes important analyses of the TFRP itself (some case citations omitted):
The insurance policy does not define “penalties,” and Mortenson argues that therefore it is ambiguous and we must interpret the term as favorably to Mortenson as reason allows.  So interpreted, the term does not, he continues, encompass the penalty imposed by section 6672(a), because it is not “really” a penalty.  He offers a number of reasons why it is not. One is that the aim is to collect taxes rather than to punish the willfully delinquent responsible person, as shown by the fact that it is the policy of the Internal Revenue Service not to use the statute to collect more than the total amount of unpaid tax.  So if the unpaid tax were $250,000, which would make each responsible person who had willfully failed in his duty to see to its payment liable for a $250,000 penalty, the total penalties assessed against all those responsible persons would be capped at $250,000.  For example, if the IRS was able to collect $100,000 of the $250,000 in unpaid tax from the company itself, the penalties collected from the responsible persons would be capped at $150,000.    
* * * * 
[P]enalties are frequently imposed for conduct well short of deliberate wrongdoing.  Reckless and negligent homicide are crimes, fines are imposed for speeding even when the driver was unaware that he was exceeding the speed limit, and there are even strict liability crimes, where the defendant's state of mind is irrelevant and even the fact that he could not have prevented the criminal act from occurring is not a defense.  Willfulness within the meaning of section 6672(a) “means that the person either knew the taxes were not being turned over to the government and nonetheless opted to pay other creditors, or recklessly disregarded a known risk that the taxes were not being paid over.”  We went further and held  that gross negligence is sufficient to constitute willfulness under the statute.   \ 
Although it is true that the Internal Revenue Service caps the penalty at the amount of tax due, this is not a statutory limitation; it is simply an enforcement policy.  The fact that the statute now allows contribution does not cap the penalty at the amount of taxes either, or for that matter impose any other ceiling.  Contribution is not about total liability, but about its allocation among the wrongdoers.  In a case in which the amount of tax due was $250,000, and two responsible persons were each liable for the penalty, the government could if it wanted assess and collect $250,000 from each.  The two would be free to seek contribution from other responsible persons, perhaps even to rearrange the liability voluntarily between themselves by means of an indemnity agreement * * *; but their obtaining contribution whether from each other or from others would not change the fact that the government had collected penalties twice as great as the amount of taxes owed.  And finally the fact that the IRS uses section 6672(a) as a collection device does not distinguish it from a number of unmistakably criminal penalties, such as those for minor thefts, vandalism, and other minor property crimes, where the police use the threat of prosecution to induce the wrongdoer to make restitution to his victim more often than they actually prosecute.  
We conclude that section 6672(a) imposes the civil counterpart of a fine. Monetary penalties for wrongful conduct are civil fines, and are encompassed by the "fines or penalties" provision in the insurance policy. * * * *  
We have yet to mention the most compelling argument against the interpretation for which Mortenson contends.  For obvious reasons, insurance companies try to avoid insuring people against risks that having insurance makes far more likely to occur.  The temptation that insurance gives the insured to commit the very act insured against is called by students of insurance “moral hazard” and is the reason that fire insurance companies refuse to insure property for more than it is worth-they don't want to tempt the owner to burn it down.  Consider the likely effects of insuring against the section 6672(a) penalty.  When a firm gets into financial difficulties and creditors are pressing it for repayment, the firm tries -- Opelika tried -- to pay the most pressing creditors currently and hold off the others till later. * * * *  This tendency is one of the reasons for the rules against preferences in bankruptcy, * * *, preferences being the favoring, often, of the most exigent creditors to the prejudice of the others, as the firm struggles to stay afloat. (When it sinks, the rest of the creditors go down with it.)  The temptation to put the IRS at the end of the line is great.  The IRS is unlikely to be aware that the firm is in difficulty, and if the firm decides therefore not to remit payroll taxes as they come due, but to favor the creditors who are threatening to seize the firm's assets or petition it into bankruptcy, the IRS is unlikely even to notice for some time that it is being stiffed.  By the time it wakes up, the firm will probably be unable to pay the taxes that it failed to remit.  It is to prevent firms from yielding to the temptation to put the IRS at the end of the creditor queue that Congress has imposed liability for nonpayment of payroll taxes on the responsible officers of the firm.  For those persons to be insured against this liability will tempt them to do just what Opelika did here and what the penalty provision of section 6672(a) is designed to prevent -- pay other creditors first, funding the preference by not paying the IRS at all. It would be ironic to use the IRS's policy of lenity in forgoing multiple collection of the statutory penalty to reduce the likelihood of its collecting the taxes for the nonpayment of which the penalty is imposed.  
It is strongly arguable, indeed, that insurance against the section 6672(a) penalty, by encouraging the nonpayment of payroll taxes, is against public policy, so falling under the last clause of the policy exclusion and possibly under the rule in Illinois as elsewhere that forbids certain types of insurance as being against public policy because of the acute moral hazard that the insurance creates.  [Discussion of this issue omitted.]  We need not decide, however, whether insuring against the section 6672(a) penalty falls within this ban. For purposes of interpreting this insurance policy, a penalty is a penalty is a penalty. 
Can you articulate why the TFRP may be a penalty for insurance purposes but not for tax purposes?  You will recall that, although the Code calls the TFRP a penalty, the cases discussing it usually say that it is remedial in nature and thus not like a penalty.  What about Judge Posner’s comment that the TFRP is indistinguishable restitution under threat of prosecution in a run-of-the-mill state criminal proceeding, which, he thinks, has penalty characteristics?  Is restitution a penalty in any sense?

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