The Bottom Line:
The use of corporations is intended to protect individuals from personal liability for the corporation’s unpaid obligations. When corporations become insolvent, absent personal guarantees, this is usually the case. But, it’s not always the case. When an insolvent corporation fails to pay “trust fund” taxes, an officer of that corporation may be held personally liable for the nonpayment under the “responsible person” doctrine. The Fifth Circuit’s recent decision in Conway v. United States, No. 10-40485, 2011 U.S. App. LEXIS 14726 (5th Cir. July 19, 2011), is a reminder that such liability can be a real risk.
Michael Conway founded National Airlines in 1995 and served as its president, chairman, and CEO until its chapter 7 liquidation eight years later. Pursuant to 26 U.S.C. § 4261, airlines are required to collect excise tax payments from passengers, hold these payments in trust for the federal government, and ultimately deliver them to the Internal Revenue Service (IRS). On December 2, 2000, National tendered a check for $1.8 million in excise taxes to the IRS. Shortly thereafter, and before the check was cashed, National filed for bankruptcy and the payment was stopped. National continued making regular excise-tax payments for amounts collected postpetition, but never satisfied the $1.8 million outstanding.
Shortly after September 11, 2001, National stopped making postpetition excise tax payments. However, National did pay certain other creditors during this time as it sought to continue operations. On January 29, 2003, the IRS made a request for payment of $11.6 million then allegedly owed by National, and brought assessments totaling nearly $8.5 million against Conway personally. Shortly thereafter, National converted to chapter 7 with the excise taxes remaining unpaid.
In response to the assessments against him, Conway made partial payments and then filed for a refund of those amounts, which was denied by the IRS. Conway then brought suit in the District Court for the Eastern District of Texas seeking a refund of the payments he had rendered and an abatement of the remaining amounts assessed. The district court found Conway liable for National’s tax deficiency as a “responsible person” for the purposes of 26 U.S.C. § 6672(a), which imposes personal liability on “[a]ny person required to collect, truthfully account for, and pay over any tax imposed under this title who willfully fails to . . . pay over such tax” to the IRS.
Conway appealed, and the Fifth Circuit Court of Appeals affirmed on the basis of a six-factor test used in determining whether someone is a “responsible person.” These factors consider whether a party in question:
- is an officer or member of the board;
- owns a substantial amount of stock in the company;
- manages the day-to-day operations of the business;
- has the authority to hire or fire employees;
- makes decisions as to the disbursement of funds and payment of creditors; and
- possesses the authority to sign company checks.
Conway, 2011 U.S. App. LEXIS 14726 at *5 (citing Barnett v. IRS, 988 F.2d 1449, 1455 (5th Cir. 1993)).
The Court of Appeals found against Conway as to each of these six factors, holding that he had an obligation to ensure payment both of the prepetition and postpetition excise tax deficiencies.
Why the Case is Interesting:
While the legal grounds on which the Fifth Circuit ruled are not particularly novel, the case is a stark reminder that a responsible person can be held accountable for unpaid trust fund taxes (which can include excise, sales and withholding taxes).