Tax Court Holds the TFRP is a Penalty Subject to § 6751(b) Supervisor Written Approval Requirement (1/23/20)

Update 1/27/20 9:15am:  Bryan Camp offers an excellent discussion of Chadwick:  Bryan Camp, Lesson From The Tax Court: §6672 Trust Fund Recovery Penalty Is Really A Penalty ... Sort Of (Tax Prof Blog 1/27/20), here.

The Tax Court has been on a tear recently with precedential (including reviewed) T.C. opinions and significant T.C.M. opinions dealing with the nuances of § 6751(b)’s immediate supervisor written approval requirement.  See e.g., FTP2019 Update 05 - § 6751(b)'s Requirement for Supervisor Written Approval for Penalties (1/11/20; 11/23/20), here.  Tuesday, the Tax Court dropped another decision, Chadwick v. Commissioner, 154 T.C. ___, No. 5 (2020), here, holding that

A TFRP [Trust Fund Recovery Penalty in § 6672] is a “penalty” within the meaning of I.R.C. sec. 6751(b)(1). It is thus subject to the requirement that written supervisory approval be secured for the “initial determination of such assessment.

As I noted in the blog above, that was still an open issue, although Tuesday's Chadwick opinion, though precedential in the Tax Court, does not necessarily close the issue.  The IRS had taken the position that the TFRP is not a penalty for § 6751(b)’s immediate supervisor written approval requirement and may appeal.

The relevant portion of the opinion is Slip Op. 11-17.  That’s relatively short (those interested must read it), so I’ll just bullet point the key points in the Court’s analysis.

• The Code calls the TFRP a penalty.  “Section 6672 was in place in 1998 when Congress enacted section 6751, and Congress is presumed to have known that section 6672 refers to the liability it creates as a ‘penalty.’” (See Slip Op. 11 n. 2.)
• Congress placed § 6672 among the penalty sections of the Code.
• Section 6751(c) says that penalties include “includes any addition to tax or any additional amount.”
• The TFRP imposes liability for “willful” conduct, imposed as a sanction for not doing something.  “From the standpoint of the person sanctioned, they are “penalties” both as denominated by the Code and in the ordinary sense of the word.” (Slip Op. 15.)
• Apparently addressing the IRS argument that TFRP was a tax because assessed and collected in the same manner as taxes, the applicable section simply says that the TFRP and other penalties are collected “assessed and collected in the same manner as taxes.”  So this argument would exempt from § 6751 many penalties to which it plainly applies.  (Slip Op. 16.)

JAT Comments:

The TFRP and the § 6751(b) Requirement for Supervisor Written Approval (11/9/15)

In United States v. Rozbruch, 2015 U.S. App. LEXIS 19223 (2d Cir. 2105), here, a nonprecedential opinion, the Second Circuit sustained the district court's holding that the TFRP penalty in the case under § 6672, here, did not fail the requirement in § 6751(b), here, for the written approval of "the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate."  The Court's holding is cryptic, so I will include the entire discussion of the argument on appeal:

Appellants argue that the District Court erred in holding that TFRPs imposed pursuant to Section 6672(a) of the Internal Revenue Code, 26 U.S.C. § 6672(a), do not trigger the written supervisory approval requirement of Section 6751(b)(1), id. § 6751(b)(1). But even assuming, without deciding, that TFRPs are governed by Section 6751(b)(1), the record here nevertheless supports a finding that the Government functionally satisfied Section 6751(b)(1)'s written supervisory approval requirement. Thus, we affirm the District Court's grant of summary judgment, which reduced to judgment Appellants' unpaid TFRPs. See Thyroff v. Nationwide Mut. Ins. Co., 460 F.3d 400, 405 (2d Cir. 2006) ("[W]e are free to affirm a decision on any grounds supported in the record, even if it is not one on which the trial court relied.").

Apparently the Court cited Thyroff because the district court had not held for the Government based on functional satisfaction of § 6751(b)'s requirement.

The briefs are helpful in understanding how the Court threaded the needle to get to a summary affirmance while avoiding having to decide whether the TFRP was even subject to § 6751(b).  The briefs are here.

• Appellant's opening brief, here.
• Appellee U.S. Answering brief, here.
• Appellant's reply brief, here.

The gravamen of of the Appellant's argument is that the TFRP is a penalty subject to § 6751(b) because Congress said the TFRP is a penalty.  Appellant does make some policy arguments, but the force of the argument is that the TFRP is a penalty because Congress said so.  And this is true even though it functions, unlike other penalties, as simply a collection mechanism.  The Government's argument is that, although labeled a penalty, it is really just a fall-back collection device for the trust fund tax that was not withheld and paid over.  The applicability of § 6751(b) to the TFRP has not yet been decided, so, rather than decide the issue, the Court said that, even § 6751(b) did apply, there was functional satisfaction of the requirement.  I presume functional satisfaction is something like substantial compliance.  The reason, as recounted in more detail in the Government brief is that manager level approval was given in the process required to approve the TFRP.

Here is the relevant portion of the argument from the Government's brief (pp. 9-10):

Correction to Books on Trust Fund Recovery / Responsible Person Penalty (10/22/15)

The IRS Policy Statement formerly P-5-60, quoted at p. 493 of the student edition and p. and p. 711 of the Practitioner edition, on the TFRP / Responsible Person penalty under § 6672 has been restated as Policy Statement 5-14 and the paragraphs renumbered.  Policy Statement 5-14 appears in relevant part in the IRM, here, as follows:

1.2.14.1.3  (06-09-2003)Policy Statement 5-14 (Formerly P-5-60) 

* * * * 

4. Determination of Responsible Persons 

5. Responsibility is a matter of status, duty, and authority. Those performing ministerial acts without exercising independent judgment will not be deemed responsible.\ 

6. In general, non-owner employees of the business entity, who act solely under the dominion and control of others, and who are not in a position to make independent decisions on behalf of the business entity, will not be asserted the trust fund recovery penalty. * * * * 

* * * *

Revised Opinion in TFRP Case Involving Flora Full Payment Requirement (1/29/14; 2/21/14)

I recently blogged on the Court of Federal Claims' Kaplan case, Kaplan v. United States, 2013 U.S. Claims LEXIS 1530 (10/9/13) application of the Flora rule in the Section 6672, TFRP contextg.  See Litigating Trust Fund Recovery Penalties -- the Flora Rule, Divisible Taxes and Unfairness (Federal Tax Crimes Blog 10/11/13), here.  Readers unfamiliar with the contents of that blog entry might want to review it.  The essence of the concern discussed was a dismissal because of the taxpayer's inability to prove sufficient payment of the TFRP divisible tax for one employee per quarter and show that the amount he paid ($100) was sufficient.

Judge Wheeler has a revised the opinion, Kaplan v. United States, 2014 U.S. Claims LEXIS 24 (2014), here.

Here is the basis for the new opinion:

However, in order to establish the Court's subject matter jurisdiction, Mr. Kaplan must prove by a preponderance of the evidence that he has paid the assessed tax for at least one employee. Cencast Servs., L.P. v. United States, 94 Fed. Cl. 425, 435 n.7, 439 (2010), aff'd, 729 F.3d 1352 (Fed. Cir. 2013). More precisely, he must show that his payments of $100 were sufficient to cover the full assessment attributable to at least one employee in each quarter. This, of course, cannot be done without some record of the amount of payroll taxes assessed per employee per quarter. In his motion for reconsideration, Mr. Kaplan relates in detail his diligent but futile efforts at obtaining these records. Pl.'s Mot. for Recons. 6-11. He then explains that he is unable to provide this evidence for exactly the same reason he is not liable for the assessed taxes, that is, he is not a responsible person under § 6672. Id. at 12. 

Thus, assuming these representations are true, Mr. Kaplan is caught in an "evidentiary Catch-22." In order to prove the merits of his argument that he is not a "responsible person," he must first produce the evidence for which he is not responsible. This inequity is magnified by the fact that the Government is itself unable to state what minimum payment would be sufficient. See id. at 9-10; Def.'s Resp. to Pl.'s Mot. for Recons. 7.\ 

In the end, the merits of this case will turn on whether Mr. Kaplan is liable for the full $86,902.76 penalty, and the divisible amount at issue is merely representative of that full amount. Indeed, "[w]hen a taxpayer sues for a refund based on a divisible refund claim, it is meant to 'test the validity of the entire assessment. '" Cencast, 729 F.3d at 1366 (quoting Lucia v. United States, 474 F.2d 565, 576 (5th Cir. 1973)). Under the circumstances of this case, the Court is not inclined to prevent Mr. Kaplan from challenging that full assessment in this forum simply because the representative amount he paid might not be representative enough. Accordingly, the Court accepts the three $100 payments as sufficient to establish subject matter jurisdiction. See, e.g., Schultz v. United States, 918 F.2d 164, 165 (Fed. Cir. 1990) (accepting plaintiff's payment of $100 toward the $20,691.38 penalty assessed against him); Cook v. United States, 52 Fed. Cl. 62, 66 (2002) ($97,760.00 penalty).

I don't have time to develop the concept here, but I think this is a further holding in a line of cases that responsibly mitigate the full bore and inequitable application of the Flora rule.  Congratulations to Professor Rubinstein, counsel for the taxpayer, and kudos to Judge Wheeler.

Addendum 2/21/14 11:30 pm:

Professor Rubinstein has written two outstanding guest blogs for Procedurally Taxing.  They are:

• Refund Suits, Divisible Taxes and Flora: When is a representative payment representative enough? Part 1 (2/17/14), here.
• Refund Suits, Divisible Taxes and Flora: When is a representative payment representative enough? Part 2 (2/19/14), here.

Allocation of Employment Taxes Between Trust Fund and NonTrust Fund Portions (6/28/13)

In Westerman v. United States, 718 F.3d 743 (8th Cir. 2013), here, the Eighth Circuit affirmed the district court's grant of summary judgment in a trust fund recovery penalty ("TFRP") case.  Although the decision blazes no new trails, it does offer a reasonable, if flowery, discussion of the importance of designating how payments of employment taxes are to be applied.  

The pattern was typical.  The corporate employer started experiencing cash flow problems and only sporadically forwarded checks for its accumulating employment taxes.  When forwarding the checks, the corporation did not designate how the IRS should apply the payments among the components of the employment taxes.  The components are the trust fund portion (consisting of the taxes withheld from the employees -- i.e., the employees' income tax withheld and the employees' share of FICA, and Medicare tax) and the nontrust fund portion (consisting of the employer's share of FICA and Medicare tax).  This division between the trust fund portion and the nontrust fund portion is important, because the responsible person(s) in the corporation can be assessed the TFRP for the unpaid trust fund portion.  As is typically the case, in the absence of designation, the IRS applied the payments to the nontrust fund portion for delinquent employment taxes.  The IRS assessed the unpaid trust fund tax liability against Mr. Westerman, the president and owner of the corporation.  He paid the amount in full, apparently $35,824.45.  In the litigation, He agreed that he was liable for $28,955.15 of that amount but urged that the IRS should have allocated the payments mentioned above to the trust fund tax liability so that he was not liable for the balance.

The Court opens the discussion with a discussion of his liability for the TFRP.  I find portions of that discussion confusing, so I forgo reviewing that discussion.  I understand it enough to know that there is nothing new or particularly elucidating in the discussion.  In broad strokes, a person is liable for the TFRP is that person had the practical authority and ability to insure the TFRP is paid and, in practical terms, caused other creditors to be paid when the TFRP  was not paid.  I do wonder why the Court felt it necessary to engage in the liability discussion since Mr. Westerman appears to have conceded his liability (he was, after all, the president and sole owner) and was only concerned about the IRS's allocation of the corporate payments of employment taxes.

So, I turn to that allocation issue, which involves only approximately $7,000.  The Court first confirms that, in the absence of the employer's designation of how to allocate the employment tax payments, the IRS may "apply the payment first toward the employer's non-trust fund liabilities for the quarter and, only once that obligation is fully satisfied, toward the quarter's trust fund liabilities."  Mr. Westerman argued that, even in the absence of a designation, the payment of employment taxes should be applied ratably to the various components of both the trust fund and nontrust fund portions of the employment taxes.  Here is the Court's discussion of that issue (footnotes omitted):

TFRP Refund Suits - How Much Must be Paid (1/18/13)

I write today on the Government's position -- pressed only once that I am aware of and not accepted or specifically rejected by any court that I am aware of -- that the Trust Fund Recovery Penalty (TFRP) (and any other divisible tax) must meet the Flora full payment rule for each assessed quarter.  For the TFRP, because of the divisible tax concept, only one employee's tax must be paid for a quarter.  But, practitioners filing a TFRP refund suit should consider the impact of the Government's argument should it continue to press it.  I have previously written on the case, but addressed the issue toward the end of that blog entry.  Ah, the Flora Full Payment Rule Raises Its Ugly Head (Federal Tax Procedure Blog 1/16/13), here.  I have decided to present the issue as a separate blog entry because TFRP refund suits are very common; if the Government is correct, the position could require dismissal of the refund suit if the minimum payments are not made for each quarter.

I present the issue by cutting and pasting my revised discussion in my Federal Tax Procedure book and now offer the following excerpts that she the background for the issue and the Government's argument (most footnotes omitted):

The TFRP is generally litigated in refund suits in either the district court or Court of Federal Claims.  There is no “ticket to the Tax Court” (notice of deficiency) in TFRP cases. Denial of access to the Tax Court -- which is a prepayment forum for litigating liability -- can have a harsh effect.  The Flora rule requires in tax refund suits that the tax must be fully paid before the taxpayer may file a refund suit.  It is not unusual for trust fund penalties to be quite large and thus prohibitive if the Flora rule were to apply full bore.  Fortunately, the due process issues – and certainly general fairness issues – that might otherwise inhere in the full bore application of the Flora rule are avoided by two procedural techniques -- one statutory and the other non-statutory -- that permit the putative responsible person to litigate the liability without payment of the entire amount.

Ah, the Flora Full Payment Rule Raises Its Ugly Head (1/16/13)

In Roseman v. United States, 2013 U.S. Claims LEXIS 2 (2013), here, a nonpublished opinion and order, the Court of Federal Claims (Judge Allegra) dismissed the taxpayer's trust fund recovery refund suit for failure to meet the prepayment requirement for refund suits.  This just applies the so-called Flora rule (see Flora v. United States, 362 U.S. 145, 150 (1960)) that a refund suit requires full payment, a rule that is mitigated in so-called divisible tax cases to require only the payment for one such divisible tax.  I explain this below, but first address the Rosenman opinion.

The body of the opinion is short, but a good reminder for practitioners and their clients:

Jurisdiction in this tax refund suit lies, if at all, under 28 U.S.C. § 1491(a)(1). n2 As a general rule, before bringing a refund suit, a taxpayer must, inter alia, pay his or her full tax liability. See Shore v. United States, 9 F.3d 1524, 1526 (Fed. Cir. 1993) (citing Flora v. United States, 362 U.S. 145, 150 (1960)); see also Ledford v. United States, 297 F.3d 1378, 1382 (Fed. Cir. 2002). This rule, however, does not apply to so-called divisible taxes, including the penalty under section 6672. Rather, "a taxpayer assessed under section 6672  need only pay the divisible amount of the penalty assessment attributable to a single individual's withholding before instituting a refund action." Boynton v. United States, 566 F.2d 50, 52 (9th Cir. 1977); see also Steele v. United States, 280 F.2d 89, 90-91 (8th Cir. 1960). n3 Courts have held that this requirement is satisfied where a plaintiff pays the penalty attributable to one employee's wages for one quarter. See, e.g., Ruth v. United States, 823 F.2d 1091, 1092 (7th Cir. 1987); USLIFE Title Ins. Co. of Dall. v. Harbison, 784 F.2d 1238, 1243 n.6 (5th Cir. 1986); Boynton, 566 F.2d at 52; Suhadolnik v. United States, 2011 WL 2173683, at *5 (C.D. Ill. June 2, 2011); Todd v. United States, 2009 WL 3152863, at *3-4 (S.D. Ga. Sept. 29, 2009); Lighthall v. Comm'r of Internal Revenue, 1990 WL 53127, at *2 (N.D. Ill. Apr. 12, 1990), aff'd, 948 F.2d 1292 (7th Cir. 1991). n4
   n2 It is worth repeating that jurisdiction for refund suits in this court is not provided by 28 U.S.C. § 1346. See Hinck v. United States, 64 Fed. C1. 71, 74-76 (2005), aff'd, 446 F.3d 1307 (Fed. Cir. 2006), aff'd, 550 U.S. 501 (2007).
   n3 "This relaxed requirement is based on the theory that section 6672 assessments represent  a cumulation of separable assessments for each employee from whom taxes were withheld." Boynton, 566 F.2d at 52.
   n4 Defendant argues that payment must be made for one employee for each of the periods involved. Given the facts presented, this court need not address this argument. 

Plaintiff's payment of $25 per quarter satisfies neither the Flora "full payment" rule nor the Boynton exception for divisible taxes. As confirmed by the tax records filed in this case, the penalties in question were imposed based on a finding that plaintiff was an employee of his corporation. The amount of employment tax owed with respect to plaintiff for any of the quarters at issue far exceeds the $25 payment amount. Accordingly, the jurisdictional prerequisite for bringing this refund action has not been satisfied. 

Based on the foregoing, the court GRANTS defendant's motion to dismiss under RCFC 12(b)(1). The Clerk is hereby ordered to dismiss the complaint.

Failure of Employer to Designate Payment to Employer's Trust Fund Taxes (12/10/12)

In paying less than all of the tax assessments that are due, it may become critical for the taxpayer to designate how the tax payment should be applied among the tax, penalties and interest, as a recent decision of the Sixth Circuit reminds us.  In re: Southeast Waffles, LLC v. United States, 2012 U.S. App. LEXIS 24991 (6th Cir. 2012), here.  In that case, the employer sent in undesignated payments to be applied against assessments for the employer's withholding tax obligations, penalties and interest.  As undesignated payments, the IRS applied the payments to the employers penalties.  The employer then went into bankruptcy.  In the bankruptcy proceeding, the employer argued that the application of the payments to the penalties was voidable because the penalties would have had a lower priority and would have been discharged, vis-a-vis the employer, in the bankruptcy proceeding.  (Note that these are penalties for the employer's direct payment obligation and are not trust fund recovery penalties (TFRP) under Section 6672 even though they relate to the trust fund liability; as to responsible persons, TFRP are not dischargeable.)

In my Federal Tax Procedure Text I discuss the issue of designating payment as follows (footnotes omitted):

We focus now on the issues confronting the taxpayer in making the payment of less than the amount of the IRS assessment.  The question here is whether the taxpayer can designate as among the various components of aggregate tax owed (e.g., as among years or within the same year as among taxes, penalties and interest). 

The taxpayer is permitted generally to so designate a voluntary payment to the IRS.  Voluntary for this purpose means any payment not resulting from the Government’s compulsory collection measures (e.g., levy), that we discuss later in this chapter.  If, however, the taxpayer fails to designate the application of the payment, the IRS can apply the payment as it sees fit. 

Designation may be critical in certain cases.  We shall give examples which are by no means exhaustive, but should illustrate the concepts:

Trust Fund Recovery Penalty and Judge Posner

Judge Posner has been much in the news recently.  Last night in the UH Tax Procedure Class we covered the Trust Fund Recovery Penalty ("TFRP"), also known as the responsible person penalty.  In my Tax Procedure Book, I conclude my discussion of the TFRP with an extended quote from Judge Posner's decision in Mortenson v. National Union Fire Insurance Co., 249 F.3d 677 (7th Cir. 2001).  I have included that conclusion in a prior blog titled Trust Fund Recovery Penalty (TFRP) Procedures (10/3/12), here.  I therefore won't repeat it here, but encourage readers to go to that blog entry to read it.  Judge Posner just has a way to summarize key concepts in memorable ways.

Judge Posner expounds on topics well beyond the law.  Judge Posner and his colleague, Gary Becker, co-host a blog where they interact on significant issues of the day, particular in the intersection of the law and the economy.  The Blog is called the Becker-Posner Blog.  Judge Posner's Wikipedia entry is here; Gary Becker's Wikipedia entry is here.  They recently had this exchange in two entries:: Richard Posner, Luck, Wealth, and Implications for Policy--Posner (The Becker-Posner Blog 10/14/12), here, and Gary Becker, Luck and Taxation-Becker (10/14/12), here.

Judge Posner has some fascinating analyses about the proper level of taxation and whether anyone "deserves" to pay less than some normative level of tax.  Some provocative excerpts that he is prepared to back up:

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.

Trust Fund Taxes, Including Collected State Sales Taxes, Are Not Dischargeable in Bankruptcy (7/21/12)

In In re: Calabrese, ___ F.3d ___, 2012 U.S. App. LEXIS 14897 (3d Cir. 2012), here, the Third Circuit held that state sales taxes that a seller collects from purchasers is a trust fund tax that is not dischargeable in bankruptcy.  The bankruptcy statute exempts from discharge "trust fund" taxes.  

The issue as posited by the Court was:

We must decide whether the sales taxes held by Calabrese are "trust fund" or "excise" taxes under 11 U.S.C. § 507(a)(8). Excise taxes receive priority, and are non-dischargeable, if they are less than three years old, as measured from the date of the bankruptcy petition. See 11 U.S.C. § 507(a)(8)(E) (priority); 11 U.S.C. § 523(a)(1)(A) ("A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt . . . for a tax or a customs duty . . . of the kind and for the periods specified in section 507(a)(3) or 507(a)(8) of this title, whether or not a claim for such tax was filed or allowed . . . ."). Trust fund taxes are always prioritized and are never dischargeable irrespective of the age of the debt. See 11 U.S.C. §§ 507(a)(8)(C), 523(a)(1)(A). 

Three of our sister courts of appeals have considered the question presented here. In each case, the court determined that the statutory text of § 507(a)(8) does not resolve the dispute. See Shank v. Wash. State Dep't of Revenue, Excise Tax Div. (In re Shank), 792 F.2d 829, 832 (9th Cir. 1986); DeChiaro v. N.Y. State Tax Comm'n, 760 F.2d 432, 435 (2d Cir. 1985); Rosenow v. State of Ill., Dep't of Revenue (In re Rosenow), 715 F.2d 277, 279 (7th Cir. 1983). Proceeding to analyze the legislative history, all three concluded that a sales tax paid by a third party is a trust fund tax within the meaning of subsection (C), and not an excise tax under subsection (E).