Employers are responsible for withholding income and employment taxes from their employees. These taxes are referred to as trust fund taxes because the employer is only holding the money for the employee to pay the IRS. When an employer fails to withhold the money and pay it to the IRS, individuals who are “responsible” and “willful” can be personally liable for the trust fund recovery penalty. Responsible persons are often officers of the employer, members of a board of trustees, directors, and shareholders. Responsible persons can be held personally liable under Internal Revenue Code section 6672.
The IRS has a long-established policy that the purpose of section 6672 was to recover trust fund taxes and not as imposing any additional penalties. As such, if the employer were to pay all the trust fund taxes back, the responsible person would not owe anything additional.
Typically, penalties must be approved in writing by the IRS employee’s supervisor prior to the initial determination that the penalty is due. “No penalty under this title shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination.” IRC 6751(b)(1). However, Trust fund taxes were interpreted as a ‘recovery’ instead of a ‘penalty’ which requires no supervisory approval before imposing methods to recover the unpaid trust fund taxes. This all changed on January 21, 2020 when the United States Tax Court published the David J. Chadwick v. Commissioner decision.
In Chadwick, Mr. Chadwick was a sole member of two entities which had failed to pay employment taxes. The two Revenue Officers that were assigned decided that Mr. Chadwick was liable for the trust fund recovery penalty. The two Revenue Officers signed off on the paperwork and issued a letter giving Mr. Chadwick the opportunity to appeal. However, he did not appeal and so the Internal Revenue Service (IRS) assessed the penalties.
The IRS argued that there was no need for a supervisor’s approval since the trust fund recovery penalty was merely a collection tool and not a true penalty. The court disagreed, stating, “Like penalties for failure to file returns and failure to disclose information, the trust fund penalties are imposed as a sanction for failing to do 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.” Chadwick v. Commissioner.
The decision in Chadwick makes clear there must be supervisory approval for the trust fund recovery penalty. Relying on another recent case, the court found the approval needed to occur prior the letter where the IRS formally notifies the taxpayer of its definite decision to assert the trust fund recovery penalty.
While this is the current case law on Trust Fund Recovery penalties in Tax Court, it is subject to review in federal district court. This is due to the fact that most decisions regarding Trust Fund Penalties are made in federal district courts and Tax Court decisions are not binding on the federal courts.
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Published by Lauren Lee
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