Current Federal Tax Developments

View Original

No Reasonable Cause Defense to Trust Fund Penalty Allowed in Ninth Circuit, CEO Liable for Responsible Person Penalty

In the case of United States v. Liddle, 119 AFTR 2d ¶2017-381 (USDC, ND CA) the CEO of two different companies that each had failed to remit trust fund taxes argued that while he was clearly a responsible person for purposes of the trust fund penalty, he should not be liable because he had acted with reasonable cause.

Some Circuit Courts of Appeal have taken the position that a responsible person may be relieved of liability for the trust fund recovery penalty under IRC §6672 based on a reasonable cause defense. 

As the District Court opinion notes:

The Second Circuit recognizes a reasonable cause defense to liability under § 6672 where the responsible person reasonably believed the trust fund taxes were being paid. See Winter v. United States, 196 F.3d 339, 345 (2d Cir. 1999). The Fifth Circuit has found reasonable cause where the responsible party relied upon advice of counsel. See Newsome v. United States, 431 F.2d 742, 748 (5th Cir. 1970). The Tenth Circuit applies the defense where the responsible person's efforts to pay the taxes have been frustrated by circumstances outside his or her control. See Smith v. United States, 555 F.3d 1158, 1170 (10th Cir. 2009).

In this case the taxpayer became aware that the first company (Home Director Technologies, Inc.) had failed to pay its trust fund taxes in October or November of 2004.  The taxpayer discussed the matter with the CFO of the company and the Board of Directors.  While the Board passed a resolution that the company would pay its trust fund taxes and not allow them to go unpaid in the future, the CEO, CFO, and other company officials decided to pay payroll and other operating expenses while the trust fund taxes remain unpaid.

The same person that was CFO of Home Director Technologies, Inc. was also the CFO of Home Director, Inc., a company that Liddle was also the CEO of from January 1, 2007 through March 31, 2008.  By September of 2007 he became aware this company had also fallen behind in paying trust fund taxes while it was receiving revenue and paying other corporate obligations including payroll.

The Court noted:

The United States has presented evidence that Liddle learned of Home Director Technologies, Inc.'s failure to pay trust fund taxes at latest by October or November 2004. Liddle Dep. 7816-80:7, Exh. 3 to Sampson Decl., ECF 36-6. However, instead of ensuring that all available corporate funds were remitted to the federal government to pay down the delinquency, Liddle authorized use of corporate funds to satisfy payroll and operating expenses. Form 4180, Report of Interview with Individual Relative to Trust Fund Recovery Penalty at 4, Exh. 23 to Nicholas Decl., ECF 36-26; Stemm Dep. 65:22-25, 74:1-16, Exh. 7 to Sampson Decl., ECF 36-10.

The United States also has presented evidence that Liddle learned of Home Director, Inc.'s failure to pay trust fund taxes at latest by September 30, 2007. Liddle RFA 59, Exh. 1 to Sampson Decl., ECF 36-4. After learning of the delinquency, Liddle permitted Home Director, Inc.'s funds to be used to pay payroll and other expenses rather than to pay the overdue trust fund taxes. Liddle Dep. 230:2-231:17, Exh. 3 to Sampson Decl., ECF 36-6.

… Moreover, because Stemm acted as the CFO for both companies, Liddle had a duty to be particularly vigilant with respect to the trust fund tax obligations of Home Director, Inc. given his knowledge of Stemm's previous failure to pay trust fund taxes for Home Director Technologies, Inc. See Leuschner, 336 F.2d at 248.

Given these facts, it’s not clear that the CEO’s actions would have been deemed reasonable cause under the standards applied in the three cases in other Circuits that the taxpayer pointed to.

But the Court notes that the Ninth Circuit Court of Appeals, the Court of Appeals that would have jurisdiction to hear an appeal of this decision, simply doesn’t recognize any reasonable cause defense to the trust fund penalty. 

The opinion notes, citing Ninth Circuit holdings:

“Willfulness, within the meaning of section 6672, has been defined as a voluntary, conscious and intentional act to prefer other creditors over the United States.” Davis, 961 F.2d at 871 (internal quotation marks and citations omitted). “An intent to defraud the government or other bad motive need not be proven.” Id. Thus “conduct motivated by a reasonable cause may nonetheless be willful.” Id.

The opinion continues:

In the Ninth Circuit, even "'reckless disregard' of whether the taxes are being paid over, as distinguished from actual knowledge of whether they are being paid over, may suffice to establish willfulness." Phillips, 73 F.3d at 942. The Ninth Circuit held in United States v. Leuschner that where a CEO knew that the company's controller previously had failed to pay trust fund taxes on behalf of a different company at which both the CEO and controller had worked in the past, the CEO's failure to take action to prevent a recurrence at the second company was willfulness as a matter of law. United States v. Leuschner, 336 F.2d 246, 248 (9th Cir. 1964).

A responsible person may be liable for unpaid trust fund taxes that accrued before he became aware of the delinquency. In Davis, the Ninth Circuit held that the company's president was subject to penalty under § 6672 even if he lacked knowledge of the company's failure to pay trust fund taxes until after they were due, because after learning of the delinquency he used company funds to satisfy other creditors rather than to pay the past-due taxes. Davis, 961 F.2d at 876. The rule has been summarized as follows: "If a responsible person knows that withholding taxes are delinquent, and uses corporate funds to pay other expenses, even to meet the payroll out of personal funds he lends the corporation, our precedents require that the failure to pay withholding taxes be deemed 'willful.'" Phillips 73 F.3d at 942.

The Ninth Circuit has recognized that the standards articulated above "may seem oppressive to the employer and employees," and may result in liability where the defendant is "unwittingly" willful. Phillips, 73 F.3d at 942. However, the Court has applied these "harsh, even somewhat counter-intuitive" standards because "it is the law." Buffalow, 109 F.3d at 573.

The Court found that the CEO was liable personally for the unpaid trust fund taxes.