According to a recent report, more than 100,000 small businesses are expected to close due to the COVID-19 coronavirus pandemic. A number of companies, although not closing their doors, are experiencing significant disruptions in their operations. Companies have taken drastic steps to preserve cash holdings including a recent report that Hilton Hotels sold over $1 Billion worth of its reward points program to American Express in order to build its cash re-services. This disruption has caused companies to look for ways to reduce expenses, increase cash reserves and maintain business viability.
As companies look to navigate through the coronavirus pandemic, one area that companies should refrain from interfering with is their trust fund tax deposits. Although failing to remit trust fund taxes or under-reporting total tax liability may lead to temporary increases in cash reserves, such action creates significant risks to both the company and any “responsible person.” Willful failure to remit trust fund tax liabilities can lead to increased costs including but not limited to substantial penalties, interest and personal liability.
Trust Fund Tax
Trust fund tax liabilities are tax liabilities in which a party collects a tax obligation from an end user and then remits that tax obligation to a taxing jurisdiction on the end user’s behalf. Trust fund taxes are especially important because they are taxes that are held “in trust” on behalf of the taxing jurisdiction. This means that the party who collects the tax does not actually have any interest in funds but is holding the money for the taxing jurisdiction. Common examples of trust fund taxes include employment (payroll), sales and excise tax.
Commonly, a party who has a withholding and remittance obligation is required to withhold and remit the tax obligation using some consistent schedule. The remittance is frequently based upon the amount of collection and is usually on a monthly or quarterly basis but can include a daily deposit requirement. Companies should understand their withholding and remittance obligation schedule in order to ensure compliance.
Responsible Person Trust Fund Liability
Trust fund liability is assessed at both the state and federal level. Under Section 6672(a) of the Internal Revenue Code, the IRS can assess a Trust Fund Recovery Assessment against any responsible person for unpaid payroll taxes. A responsible person is any officer, director or an individual who makes decisions related to pay or has signature authority. An assessment under Section 6672(a) can be assessed against anyone who 1) is required to remit payroll taxes and 2) willfully fails to pay them. It’s important to understand that willfulness is more than mere negligence. In addition, states, like Ohio, have provisions that assess personal liability on a party who has control or is responsible for withholding or remitting income tax or sales tax (See R.C. §5747.07(G) and §5739.33).
Recent court cases help to highlight the significant risks to responsible persons who fail to appropriately monitor and pay their trust fund tax obligations. In U.S. v. Hartman (2018), two individuals co-founded a company, Spectrum Tool & Design. One founder (Ott) was designated as the individual tasked with the management of the payroll tax obligations including working with a third-party company to help facilitate the process. The other founder (Hartman) had signature authority on the company accounts and signed employees checks but did not actively manage the payroll process. Initially, the company used a third-party to help facilitate the calculation of payroll taxes and then Ott would write the checks for payment of the payroll taxes. However, after the third-party became aware that Ott was not paying the payroll taxes they, discontinued the relationship. Ott attempted to use a third-party software platform to assist in the payroll calculation process but continued to not pay the payroll taxes in spite of the employee’s continuing to be paid. Subsequently, Hartman became aware of the nonpayment but failed to take any corrective action to rectify the missed payments or take any action to facilitate the payment of payroll taxes. Eventually, the company went bankrupt, so the IRS assessed the outstanding payroll tax obligation directly against Hartman, as a responsible person. Hartman, unsuccessfully, argued that he should not be held personally liable because he trusted his partner to handle the payroll taxes and was not directly responsible for payroll matters. However, the court found that Hartman was a responsible person because he knew of the issue, had the ability to act and failed to do so.
There are numerous cases on both the federal and state level that outline the risks of companies failing to adhere to their trust fund tax liability. Cases similar Hartman, are cautionary tales of the importance of meeting your obligations even in downturn market situations. It is important to remember these key points: 1) If you are a business owner, understand whether you are a responsible person; 2) If you are a responsible person but do not have direct oversight of the payroll process, make sure that you have at least some insight into whether or not the company is meeting its obligations; and 3) If you know that there are issues with your trust fund tax process or obligations, then seek out the expertise necessary to address these issues.
In these uncertain times, it is vital that businesses be aware of all of their options and obligations. If you have questions about trust fund tax obligations on your business, please contact Demetrius Robinson (djr@kjk.com or 614.427.5749) or any of our Tax professionals.