Federal law requires employers to withhold income, Social Security, and Medicare taxes from employee wages. When a company experiences financial distress, payments for these payroll or “trust fund” taxes may be temporarily postponed or deliberately ignored. It is important for any business owner to understand that willful failure to pay employee taxes can bring a costly lawsuit from the IRS.
A recent Sixth Circuit Court of Appeals decision along these lines is noteworthy. Issued in July, 2018, the judge’s decision stresses the importance of ensuring that your company’s taxes remain current and confirms that a bankruptcy filing will not keep the IRS at bay.
Judgment on Payroll Taxes
The appeals court affirmed a district court decision granting the government’s motion for summary judgment against defendant “Hartman.” The appellate judge agreed with the previous court that Hartman had “willfully” failed to pay employee taxes for Spectrum Tool & Design, a company he co-owned with another party, “Ott.”
Apparently, Ott was assigned the task of ensuring that payroll taxes were paid, but he did not always do so after Spectrum experienced financial difficulties. Hartman became aware of the problem, but continued to delegate payroll responsibilities to Ott. Hartman’s reliance on Ott did not waver despite several ongoing red flags.
Eventually, Spectrum filed Chapter 11 bankruptcy, which was later converted to Chapter 7. Although a plan was in place to pay post-bankruptcy payroll taxes, some payments were still missed. Inexplicably, Hartman continued depending upon Ott for payroll obligations even after Ott was fired.
A “Reckless” Mistake
The Circuit Court’s decision cited case law stating, “A responsible person may willfully fail to pay taxes in one of two ways. He may know that the company did not pay the taxes. Or he may ‘deliberately or recklessly disregard[] facts and known risks that the taxes were not being paid.’” citing Calderone v. United States, 799 F.2d 254, 260 (6th Cir. 1986).
The Court affirmed that Hartman had recklessly disregarded an “obvious risk” that the taxes were not being reliably paid. Since he was found to have acted recklessly, there was no need to determine whether or not he actually knew taxes were not paid. Hartman was held responsible for payment of Spectrum’s unpaid payroll taxes.
Bankruptcy and the IRS
The fact is, although some federal income taxes can be discharged in Chapter 7, payroll taxes can never be purged in bankruptcy. For this reason, payroll taxes should remain a priority if your business is struggling. Being up-front with Uncle Sam and negotiating terms is your wisest course of action in this circumstance. In some cases, you may be able to arrange an IRS repayment plan or offer in compromise, which can reduce the amount of taxes owed.
Note that personal income tax can potentially be eliminated in bankruptcy court. Necessary factors for this option include the presence of an existing tax return filed and the absence of evidence of willful evasion or tax fraud. It’s important to understand that you cannot discharge a federal tax lien that was filed before you file for bankruptcy. For this reason, it is best to act quickly to avoid IRS action on unpaid income tax balances.
Are you struggling with a business or personal tax problem? Please don’t hesitate to seek assistance from the attorneys at Bunch & Brock. We offer solutions and a clear pathway forward.
