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September 11, 2020

Financial Workouts and Distressed Companies; Beware of Trust Fund Liability in These Difficult Times

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As we all know, COVID-19 has thrown us into some difficult times, both individually and professionally. For some businesses, these difficult times, and the overall economic downturn, has made it difficult to meet their daily, weekly, and monthly obligations. Certainly, by working through a financial workout or restructuring with creditors and other third-parties, those companies may be able to obtain relief and weather the storm. For others, however, they will not recover and will need to close. As part of any closure or restructuring of a business because of difficult financial circumstances, we have to consider (i) the tax ramifications of that closure/restructuring and (ii) the personal liability for the owners of those businesses. One area of potential personal liability are trust fund liabilities related to sales tax and withholding tax at the state level, and the trust fund recovery penalty at the federal level. This specific blog post will discuss the trust fund recovery penalty and the statute of limitations for the IRS to assess that penalty.  

Background Regarding the Trust Fund Recovery Penalty

Internal Revenue Code (“Code”) Section 6672, commonly referred to as the trust fund recovery penalty, is one of the most invoked sections of the Code by the IRS. The statute creates a unique vehicle for the collection of what are referred to as “trust fund” taxes (i.e., those taxes collected from employees and “held … in trust for the United States”). In the context of employment taxes, the term trust fund taxes refers only to taxes withheld from employees—federal income tax and one-half of Federal Income Contributions Act (“FICA”)—not to the portion of employment taxes that the business itself owes, such as its matching share of FICA or the Federal Unemployment Tax Act (“FUTA”).

Now, it is important to note that regardless of whether the IRS attempts to collect the unpaid taxes from the business as the primary obligor, section 6672 empowers the IRS to collect the unpaid trust fund tax liabilities of business entities from the personal assets of those persons who were responsible for the nonpayment of the taxes, including the business owners. In effect, the statute enables the IRS to “pierce the veil of limited liability” and hold many individuals secondarily or vicariously liable.

Nardone Comment: Only those persons who are responsible for the nonpayment of taxes can have personal liability under section 6672. Further, an individual may only be held responsible if they were willful in the failure to collect or pay over the required taxes. This particular blog post does not discuss the elements of the statute itself and the potential defenses to the responsible person element or the willfulness element. Rather, it only focuses on the statute of limitations. For this blog post, we assume that the person may be responsible.

Are There Limitations on the IRS Assessing the Trust Fund Recovery Penalty?

In any case where the IRS invokes or threatens to invoke Section 6672, we have to consider the IRS’s authority to do so, under the statute of limitations. Whether the IRS can assess the trust fund recovery penalty against one of the owners or other responsible parties, may depend on this analysis. Generally, the IRS has three years from the date the tax return was filed to assess the trust fund recovery penalty. 

A defense based on a statute of limitations can be a wholesale victory for the taxpayer. For this reason, the underlying taxpayer should evaluate all limitation periods. Subject to a variety of exceptions, the statute of limitations for the Service to assess the section 6672 penalty is three years from the later of April 15th following the year in issue or from the date the return was actually filed. This is true for taxes relating to all quarters of the year, as the earlier quarters’ returns are deemed “early filed.”

The principal actions likely to extend the statute of limitations in Section 6672 cases include the failure of the business to timely file the employment tax return, the individual’s written consent to extend limitations, submission of an offer in compromise, commencement of a refund suit, or challenge of a third-party summons. Similar actions by the business do not affect the statute of limitations for individuals.

Nardone Comment: It is important to ensure that all tax returns, including all employment tax returns, are timely filed when closing or restructuring a business. Otherwise, if the returns are not filed, the statute of limitations do not begin to run.

Conclusion

In sum, there are a lot of things going on when a business is restructuring or closing. And, unfortunately, one of the areas that typically does not get addressed is the filing of timely tax returns and the payment of tax liabilities. Thus, many years later, former owners and other responsible persons may be exposed to liabilities that they never thought would be personal liabilities for them individually. Thus, it is important that the business take all prudent steps to shield the owners and other responsible parties from potential liability, including ensuring that the tax returns are filed so that the statute of limitations begins to run on those returns. Further, as we will discuss in an upcoming blog, it is important that, to the extent funds are available, the business should voluntarily pay and allocate those funds to the trust fund tax liabilities. By doing so, we minimize personal exposure for the owners and other responsible persons. Do not let your distressed business and the financial difficulties of that distressed business become your personal responsibility.

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September 11, 2020

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