Tax Lawyer's Blog

Keith Fogg, Professor of Tax Law at Villanova University, says in an article posted on Social Sciences Research Network (SSRN) titled Leaving Money on the Table and Providing an Incentive Not to Pay: The Story of a Flawed Collection Device that the Section 6672 penalty is flawed:

As of September 30, 2007, the IRS had $282 billion of unpaid assessments on its books. Of that amount $58 billion, over 20%, represents the unpaid payroll taxes due from employers. The majority of payroll taxes due from employers results from income and social security taxes collected by the employer and held in trust for the Government. Internal Revenue Code section 6672 gives the Government the right to pierce the corporate veil to pursue collection of these payroll taxes collected for the Government but not paid. Because it creates personal liability, 6672 can serve as a powerful tool in the fight against the growing tax gap.

Unfortunately, 6672 is flawed in the way it operates due to its position in the Code as an assessable penalty. The interest charged under 6672 only runs from the date of the actual assessment against the individual and does not relate back to the due date of the corporate employment tax return. The flaw allows those responsible for failing to pay over payroll, and other, taxes collected from the Government to avoid paying interest for two years or more.

With friends like this, who needs enemies?

Here are my thoughts on Fogg’s proposal:

Constitutional Challenges

The IRS has the authority to penalize those whom it has determined were responsible to turn over government funds and failed to do so.

But this is decidedly different than assessing an actual tax against those persons, as Fogg seems to suggest. What basis would there be to assess a payroll tax liability (as opposed to a penalty) against an individual who did not incur that liability?  In order to do that without running afoul of the constitution, it seems to me that the government would have to prove that the individual assessed had personally pocketed or benefitted from the collected but unremitted trust fund taxes.

And if the government were required to prove personal benefit in order to assess the tax against individuals, it would, because of this much higher standard, end up with fewer, not more, sources (i.e. responsible persons) from which to collect the tax.

Trust Fund Penalty Issue Not Relevant to Ongoing Businesses

The problem Fogg describes only comes into play with respect to insolvent corporate and LLC employers. For these businesses the amount of the unpaid payroll taxes, including penalties and interest, exceeds the value of it’s assets. For employers who are solvent and will remain in business, the trust fund penalty assessment is not an issue because the corporation will eventually pay the taxes and the statutory additions.

Piercing the Corporate Veil is Not the Only Basis for IRS Ability to Collect Trust Fund Taxes

Fogg says that 6672 gives the IRS the right to “pierce the corporate veil” to pursue the trust fund portion of the payroll taxes. This is not entirely incorrect. The IRS has the right to collect the unremitted trust fund taxes from all responsible persons (even net payroll lenders) regardless of whether or not these individuals are shareholders. The corporate veil only protects shareholders of corporations from being held liable for corporate debts. Consequently, the reason the IRS can assess the penalty against responsible persons is not because it is allowed to pierce the corporate veil, but because 6672 allows it to punish individuals who fail to meet their obligation to ensure that the trust fund taxes are properly remitted to the government.

Trust Fund Penalty is a Penalty for Failure to Comply and, Therefore, Interest on it Cannot Begin to Accrue Until it is Assessed

I am not sure what Fogg means when he says “the flaw allows those responsible for failing to pay . . . to avoid paying interest for two years or more?”  Interest cannot begin to accrue on a debt until the debt exists. Before an individual is held personally liable for a trust fund penalty, the IRS must first determine whether or not that person is a responsible person within the meaning of the code. Once the IRS does that, it must give that individual the right to appeal the determination.  It is, therefore, proper that interest accrue on the trust fund penalty itself only after that penalty has been properly assessed and the taxpayer has exhausted his or her appeal rights.

Enforcement Inequities Abound: Overhaul of Entire Trust Fund Penalty Provision is Long Over Due

There are many inequities that exist in the way the IRS goes about determining responsible persons and assessing and collecting the trust fund taxes. I have seen elderly, minimum wage bookkeepers assessed trust fund penalties because the owners of the businesses listed them as officers and ordered them to sign checks while they pocketed the trust fund taxes knowing full well that the IRS wouldn’t find them responsible for the failure to remit the taxes. Often the one who benefits the most from the failure to remit payroll taxes insulates himself from the assessment of a trust fund penalty because he has to know the law in order to break it. The innocent bookkeeper, or single mother of three, who trusts her employer and needs the job often gets blindsided by the trust fund penalty.

I favor a complete overhaul in the way the trust fund penalty is determined, assessed and collected. I don’t believe that the current system that says there are no degrees of responsibility is fair. The owner, shareholder who took big salaries from the corporation and intentionally tried to arrange things to limit his exposure to the trust fund penalty is MORE responsible and therefore more liable than is the minimum wage bookkeeper who was duped into signing payroll checks.

What do you think about Fogg’s proposal? 

Also, I would love to hear from those of you who have dealt with Trust Fund Penalty assessments and the IRS’s determination of responsible persons.

Do you think the current system is fair?  What do you think should be changed?

For an excellent article on this subject see Corrie Lynn Lyle’s, The Wrath of IRC Section 6672: The Renewed Call for Change – Is Anyone Listening? If You Are a Corporate Official, You Had Better Be (PDF).

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