Agreements with Creditors

Agreements with creditors didn’t shield president from trust fund recovery penalty.

The trust fund recovery penalty, which applies to the failure to withhold the proper amount of taxes out of employees pay and to pay such amounts to the IRS, can be imposed on any "responsible person" that fits into two categories under Code Sec. 6672. The penalty is a 100% penalty, meaning that the responsible party can be penalized the same amount as the amount of taxes that were not paid. This results in the IRS being able to recover double the amount due.

Being a "responsible person" is, therefore, a high risk position. Therefore, determining who is a "responsible person" is critical. The first category in determining a "responsible person" is anyone who is responsible for collecting, accounting for, and paying over payroll taxes, and secondly, anyone who willfully fails to perform this responsibility. Thus, the responsible person can include any party within the business who fits this criterion, no matter how high their position in the company. In order to fully grasp the responsible person, a list of factors was put into action by the Fourth Circuit to determine if that employee (1) served as an officer or director of the company; (2) controlled the company’s payroll; (3) determined which creditors to pay and when to pay them; (4) participated in the corporations day-to-day management; (5) had the ability to hire and fire employees; and (6) possessed the power to write checks.

The IRS test concludes that any person who holds financial power or is defined by any of these categories or criteria can be subject for the penalty. For example, the president, treasurer and majority share holder of NCI was found liable for the trust fund recovery penalty. The courts found him liable after he failed to remit taxes from the employee’s checks to the IRS. He tried to defend by saying was not a responsible party and was shielded because the non-payment resulted from his compliance with agreements NCI had reached with creditors which resulted in there being insufficient monies to pay the IRS after payment of the creditors pursuant to their agreements.

He tried to appeal this charge but because he fit into five of the six factors, the courts held that he was in fact the "responsible party" and had a duty to pay the trust fund monies before paying the creditors. This penalty is very serious. As a side note, because the penalty was assessed against both NCI and the "responsible party, NCI was forced to declare bankruptcy.