Many small business owners and employees are unaware they could face personal liability from the IRS for unpaid employer withholding taxes. In fact, federal statute renders the corporate shield meaningless when the IRS pursues nonpayment of withholding tax. Instead, any person responsible (or having a duty to collect and pay such tax) who willfully fails to collect and pay will be personally responsible for penalties equaling the total amount of the tax evaded. This means the IRS can collect employer withholding tax from owners and employees of any company or corporation if they are deemed responsible and willfully choose not to pay. As expected, much guidance and case law has been developed to determine who is a responsible party and what constitutes willful evasion. This article seeks to briefly address such issues.
In a nutshell, a responsible person is one that had a duty to account for, collect and pay the withholding tax.
Of course this definition is still open to interpretation and, unfortunately, there is no bright-line guidance. Instead, a multitude of factors are considered:
• Identification of the person as an officer, director or principal shareholder of the corporation, a partner in a partnership, or a member of an LLC;
• Duties of the officer as set forth in the by-laws;
• Authority to sign checks;
• Identification of the person as the one in control of the financial affairs of the business;
• Identification of the person as the one who had authority to determine which creditors would be paid and those who exercised that authority;
• Identification of the person as the one who controlled payroll disbursements;
• Identification of the person as the one who had control of the voting stock of the corporation; and
• Identification of the person as the one who signed the employment tax returns.
Once an individual is determined to be responsible, the next question is whether nonpayment was willful. The definition of willful includes intentional and deliberate acts. However, courts have also found that “willful” includes recklessly disregarding an obvious risk that taxes would not be paid. For example, a responsible person failing to investigate or correct mismanagement after being notified that withholding taxes were not paid would satisfy the willful standard. The Colorado federal courts have recognized “reasonable cause” as a defense for not paying withholding tax but apply the defense narrowly. Ignorance or a mistaken belief that other creditors had priority is not a defense.
This has implications for many small business structures. First, small business owners who control operations should be aware that their corporate shield cannot protect them from personal liability if they do not pay withholding tax. Second, employees of larger entities who are tasked with employee management and payroll cannot hide behind their employer’s liability shield if they willfully or recklessly fail to pay withholding tax.
Such scenarios would apply to majority members of LLCs and majority shareholders of corporations who are also identified as officers or managers in the entity documents but have effectively delegated most business operations to another employee or minority member/shareholder. The majority member/shareholder could face personal liability for the entity’s withholding tax evasion.
As always, small business owners and those planning to begin a small business venture are well advised to seek competent professionals to advise on business structure and tax obligations. Often, the simple answer is to outsource payroll to a third-party provider. However, if owners are notified of a delinquency, they will still need to investigate and ensure that withholding taxes are being paid by the provider. As with all aspects of a small business, diligence is key.
Ian Burrell is an attorney with Stinar Zendejas and Gaithe. He can be reached at firstname.lastname@example.org.