By Robert S. Schriebman
When a corporation or an LLC falls behind in IRS or EDD payroll tax compliance the people behind the scenes have personal exposure for the payment of these taxes. Unfortunately it is a myth that members of an LLC are immune from personal exposure. This article will discuss personal liability for IRS and EDD delinquent payroll taxes in light of the recent US District Court Commander decision. (US v. Commander et al, 2017-1 USTC ¶50,194, April 3, 2017). Although "Commander" was a New Jersey case, LLC rules are pretty much standardized throughout the county. That is why the reasoning in the Commander decision can impact California LLCs.
The IRS Version - IRC § 6672 - The Trust Fund Recovery Penalty (TFRP)
The TFRP is really not a penalty. It is a carry-over from the old name "100 Percent Penalty." It is a tax assessment. Any person required to collect, truthfully account for, and pay over employee payroll taxes, who fails to do so, may be held personally liable. This means what it says - your personal savings, equity in your home, and other valuable assets are subject to seizure and collection. You can have a whipsaw situation where the corporation is making installment payments on the unpaid payroll taxes and the corporation's president and treasurer (CFO) are also making personal monthly payments. The IRS won't tell you how much is owed by each - so it becomes a huge mess.
Trust Fund taxes are composed of withheld income taxes and withheld Social Security/Medicare taxes. Because the United States is required to credit employees for these withheld "trust fund taxes" regardless of whether they are actually paid over to the Government by the employer. Slodov v. United States [78-1 USTC ¶9447], 436 U.S. 238, 243 (1978), Congress provided that an employer's responsible persons, such as officers and managers, can be held personally liable under 26 U.S.C §6672 for'trust fund recovery penalties if the trust fund taxes are not paid over when due. The Trust Fund portion is roughly 60% of what is owed by the corporation when you take into account penalties and interest.
The EDD Version - CUIC § 1735
The EDD basically has the same criteria for imposing personal liability for unpaid EDD corporate level payroll taxes. The EDD is more apt to "shoot from the hip" in assessing personal liability when compared to what the IRS goes through before making a TFRP assessment. Although EDD payroll taxes are relatively smaller than their IRS cousin, proportionately the assessment is much higher. The IRS version is about 60% of what the corporation owes, but the EDD version is a full 100% exposure. In other words, as far as the EDD is concerned, it is a true 100% penalty. EDD collection action is swift and direct. There is no collection due process procedure; bank accounts are levied without warning and are levied repeatedly.
The Commander Decision
Darren Commander and Kenneth Skerianz each owned 50% of Darken Architectural Woodwork Installation LLC (Darken). Darken owed substantial IRS back payroll taxes. In the meantime Skerianz died. Mr. Commander tried to argue that Skerianz ran the day-to-day fiscal operations of the business and that he, Mr. Commander, was not in command! The judge was no fool. He found that Mr. Commander signed checks, including payroll checks and handled affairs such as obtaining financing. The judge also reasoned that in a two-person partnership-in-reality, it was impossible for Mr. Commander to ignorant of payroll tax liabilities.
There are two elements in holding one responsible for the TFRP. The first element is being in a position of fiscal responsibility. The second element is willfulness. The judge found that Mr. Commander exercised power to pay the company's bills and sign paychecks. This was especially true after the death of the other member. As far as willfulness is concerned, the judge had this to say:
The responsible person acts willfully if he (1) clearly ought to have known that (2) there was a grave risk that the withholding taxes were not being paid and (3) he was in a position to find out for certain very easily. (Vespe, 868 F.2d at 1335). Alternately, "[a] responsible person acts willfully when he pays other creditors in preference to the IRS knowing that taxes are due, or with reckless disregard for whether taxes have been paid," (Brounstein, 979 F.2d at 956). "Reckless disregard includes the failure to investigate or correct mismanagement after being notified that withholding taxes have not been paid," (Greenberg, 46 F.3d at 246). Where the responsible person "only later becomes aware that [taxes] were not paid, he acts willfully by paying other creditors in preference to the United States, even if money specifically withheld has been dissipated" already. (Vespe, 868 F.2d at 1334).
When two or more people in a company have exposure to the TFRP it's usually going to come down to a finger-pointing contest. Commander was no exception, except Mr. Commander pointed his finger of blame at a corpse. It didn't work.
Commander makes it very clear that members of an LLC have the same TFRP exposure as officers of an S or C corporation. An LLC offers no safe harbor and no immunity. The IRS treats payroll tax deficiencies with the highest priority. Even though these days the IRS is short-handed, there are enough agents to enforce penalties and personal exposure for payroll tax non-compliance.
Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See "California Tax Collection Practice and Procedures" and "California Taxation Practice and Procedure," both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, "IRS Tax Collection Procedures - A Manual for Practitioners" published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, "IRS Tax Collection Procedures - A Manual for Practitioners" published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See "California Tax Collection Practice and Procedures" and "California Taxation Practice and Procedure," both published by Commerce Clearing House.
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