Failures by a responsible person to pay over federal employment taxes1 formerly were handled almost exclusively through the imposition of penalties under sections 6672 and 3505 of the Internal Revenue Code — strictly as matters of civil liability. Increasingly, however, the Tax Division of the U.S. Department of Justice and the Internal Revenue Service are pursuing criminal charges against those with responsibility for these failures.2 A search of news releases issued by DOJ’s Tax Division (www.justice.gov/tax) reflects that five criminal cases of this nature were pursued by DOJ so far in 2011, as compared with just two cases of this type in all of 2010, and no cases of this type in 2009.
The question posed in the headline today appears more likely to be answered in the affirmative. A recent Tax Division news release is instructive: the president of a chain of Northern Virginia and Suburban Maryland community newspapers pleaded guilty to two misdemeanor charges under § 7203 and was sentenced to six months in prison. He was also placed on a year's supervised release, with six months served in home confinement, and was ordered to make restitution. The amount of tax that he failed to pay over evidently exceeded $940,000, but federal tax prosecutors have been charging defendants where the unpaid employment taxes were approximately $200,000 — a fairly low threshold.
The usual reasons given by a high-level company official for allowing employment taxes to go unpaid are that the official was merely "trying to keep the company going and preserve jobs" and “it was just a short term loan but it got out of hand.” These excuses, while perhaps sympathetic, are non-starters as a legal defense. The employee’s share of employment taxes (so-called “trust fund taxes”) do not belong to the employer, who has a fiduciary duty to withhold and deposit them properly.
The relevant questions for company officials responsible for or authorized to pay over the taxes are:
- When was knowledge of the tax arrearage first acquired (or when should it have been acquired, if the official attempted to remain willfully blind)?
- What steps, if any, did the corporate official take to insure that the available corporate funds were applied to the tax arrearage rather than used to pay other creditors?
These questions go to whether the failure of the corporate official to ensure that the IRS was paid first was “willful,” the state-of-mind required for liability under the civil and criminal penalty statutes.
Answers to these questions are typically sought by Revenue Officers from the IRS’s Collection function during an interview done on the company premises. Sometimes, these Revenue Officers show up unannounced at the company premises and seek on-the-spot answers to a standard set of questions.3 The answers obtained are then offered by the government as admissions in a subsequent civil or criminal proceeding.
In view of the increased frequency of federal criminal prosecutions, a company official facing an employment tax arrearage may wish to consider seeking legal advice before speaking with the IRS. These communications should be protected by the attorney-client privilege. By contrast, the “federally authorized tax practitioner” privilege, found in section 7525 of the Internal Revenue Code, does not protect communications with non-lawyer tax practitioners when the communications are pertinent to a criminal investigation.
Of course, a practicing corporate lawyer who receives a call from a company official when the IRS Revenue Officers are at the door will always bear in mind that the interests of the company, and the interests of the corporate official, may sharply diverge. For example, the company may want to cooperate with the IRS so that the IRS refrains from seizing company assets, while the company official might be well advised not to cooperate based upon the potential criminal jeopardy. If interests do diverge, the company official will need to obtain independent counsel.
Civil liability is sometimes asserted against responsible persons who are not company officials, e.g., certain individuals at a payroll service provider or at a lender, surety, or other entity, who used available funds to pay creditors other than the IRS. It is unclear whether the IRS or DOJ would attempt to bring criminal charges against officials outside the corporation. Section 3505 was designed to address the civil liability of these officials, and it, along with the usual “willfulness” requirement, may complicate the government’s effort to bring criminal charges.
In sum, IRS investigations into failures to pay over employment taxes now more frequently have a criminal dimension. Company officials and others who have a role with deciding whether to pay the IRS or other creditors with limited funds face sharply enhanced risks. It is crucial that company officials and their advisers understand these heightened risks and respond appropriately.