The circumstances under which an individual can be personally liable for an employer’s failure to pay payroll taxes was the subject of Erwin v. United States, decided yesterday by the Fourth Circuit.
The Court affirmed a grant of summary judgment by Judge Beatty of the Middle District of North Carolina imposing personal liability on the Defendant, a shareholder who held various executive positions with the Company. This was a 2-1 decision, with a majority opinion from Judge Motz and a dissent by Judge Hamilton.
Individual Liability For Payroll Tax Withholding
The Court provided a quick primer on how an individual can become personally liable for payroll taxes:
- Employers are required to withhold social security and federal excise taxes from employee wages.
- Those withheld funds are held in trust for the United States, and are often referred to as "trust fund taxes."
- Once in the hands of the employer, those funds are held for the exclusive use of the government, not the employer.
- Even if the employer needs the withheld tax money to pay suppliers and vendors to keep the business operating as a going concern, it can’t, because "the government cannot be made an unwilling partner in a floundering business."
- The Internal Revenue Code imposes personal liability for payroll tax on the officers and agents of an employer who are (1) responsible for "the employer’s decisions regarding withholding and payment of the taxes" and (2) who willfully fail to see that the taxes are paid.
The Test For Determining A "Responsible Person"
In Plett v. United States, 185 F.3d 216 (4th Cir. 1999), the Fourth Circuit set out a variety of factors it would consider in determining whether an individual was a "responsible person" who should have personal liability for unpaid payroll taxes. They are:
whether the employee (1) served as an officer or director of the company; (2) controlled the company’s payroll; (3) determined which creditors to pay and when to pay them; (4) participated in the corporation’s day-to-day management; (5) had the ability to hire and fire employees; and (6) possessed the power to write checks.
Responsibility and Willfulness Established As A Matter Of Law
In the Erwin case, the Court discussed each factor, and summarized their application as follows in deciding that the Defendant was a responsible person and therefore personally liable:
Erwin admitted that at all times he owned at least one third of the stock of this closely-held corporation and served as its secretary, treasurer, vice president, and director. Erwin admitted that he signed loan documents and leases on behalf of the corporation, thus evidencing that he shared responsibility for establishing the corporation’s financial policy. Erwin admitted that he approved restaurant site selection and regularly reviewed sales data. Erwin admitted holding quarterly meetings with his partners and weekly telephone calls with the general manager to discuss the restaurants. Erwin admitted that he directed or negotiated payments to certain favored creditors to reduce [the company] debt, which he had personally guaranteed. Erwin admitted that he hired and fired upper-management employees, including [the company’s] accountants. Finally, although Erwin delegated many of the day-to-day financial responsibilities of the corporation to others, he admitted that he infused capital into [the company and admonished the [company’s accountants], over whom he had significant control, to stay current with the company’s tax obligations.
The Court then turned to the issue whether the Defendant had willfully failed to collect, account for, or pay the taxes in question. Judge Motz ruled that the Defendant’s conduct after he learned of the tax deficiencies established willfulness as a matter of law. He hadn’t taken steps to remedy the known deficiencies and had instead directed payment to other creditors.
She held that "we adopt the rule that when a responsible person learns that withholding taxes have gone unpaid in past quarters for which he was responsible, he has a duty to use all current and future unencumbered funds available to the corporation to pay those back taxes."