14 April 2017 Lack of funds is not necessarily reasonable cause for failure to remit payroll taxes to the IRS In USA V. Hodges, the Court of Appeals for the 10th Circuit upheld a district court's determination that a former nursing home manager was liable for penalties for willfully failing to pay federal employment taxes. The Court ruled that the risk of closing nursing homes and laying off employees in order to the pay the taxes owed did not represent reasonable cause. The case demonstrates not only the personal liability of responsible parties for trust fund taxes under Section 6672(a), but also the standards that apply in considering whether there is reasonable cause for abatement of this penalty. Rex A. Hodges was appointed as temporary manager of four nursing homes with control of the facilities and had "sufficient power and duties to ensure that the residents received adequate care." Hodges was in charge of day-to-day operations and was responsible for depositing the employees' payroll tax withholdings to the IRS and filing federal payroll tax returns. Hodges paid the nursing homes' operating expenses and net payroll, but failed to pay the employees' withheld payroll taxes to the IRS. Hodges was removed as temporary manager of the four nursing homes in February 2001. In October 2001, Hodges became manager of a new facility, again paying operating expenses and net payroll, but once again, he failed to remit to the IRS the federal payroll taxes withheld from the employees' paychecks. In February 2004, the IRS began assessing penalties against Hodges personally for the amount of the unpaid federal payroll taxes accrued from each facility. In 1998, Hodges and his wife purchased property as joint tenants. In 2004, Hodges transferred his interest in the property to his wife by quitclaim deed. The IRS continued assessing penalties against Hodges after the transfer, thus the tax liens continued to attach to the property after the transfer. The IRS sued the Hodges to reduce the tax assessments to judgment and to foreclose its liens on the Hodges' property. Hodges opposed and stipulated to the amount of the assessed penalties, but argued he had reasonable cause for not paying over the payroll taxes because he relied on others to pay them. The district court granted the government summary judgment on reducing the assessments to judgment and found the "reasonable cause" argument to be without evidentiary support. The court also held that the Hodges did not dispute the liens before Hodges transferred his interest in the property to his wife and granted the government partial summary judgment with respect to these liens. However, the IRS decline to initiate foreclosure on the property because the proceeds would not satisfy even the pre-transfer liens. Section 6672 penalties because he did not act willfully in failing to remit the taxes and that the district court erred in ordering foreclosure of the property. Section 6672(a) allows a penalty to be imposed on a "responsible person" who is responsible for collecting, truthfully accounting for, and paying over any taxes imposed if that person acted willfully in failing to remit the taxes. Hodges agreed to the amount of the assessments and that he is a "responsible person," but argued that he did not act willfully because he had reasonable cause for not remitting the taxes. With respect to the Section 6672 penalty, reasonable cause is determined only when (1) the taxpayer has made reasonable efforts to protect the trust funds, but (2) those efforts have been frustrated by circumstances outside the taxpayer's control. As an argument for reasonable cause, Hodges cited the urgent necessity of caring for the nursing home residents; a promise by the owner of three of the nursing homes that the owner would pay rehabilitation costs for the facilities; and an Oklahoma statute regarding a nursing home owner's responsibility for costs. Hodges did not deny that he had power to pay the taxes or that he knew they were not being paid. The court ruled that this meets the definition of willful. Hodges elaborated on his claim for the reasonable cause exception, claiming that he would have had to close the homes and hundreds of employees would have been terminated if he had remitted the taxes. He presented no evidence to support a finding that he made reasonable efforts to protect the withheld taxes; rather he voluntarily and intentionally made the decision to pay operating expenses including employees' net wages, his own salary, and other creditors, before paying the taxes. The court stated that financial concerns do not constitute "circumstances outside the taxpayer's control." Further, the court found that Hodges' reliance on the owner's promise to pay the taxes is not valid because Hodges bore the responsibility for making the payments and knew they were not being made. Hodges presented no evidence that he made any efforts to pay the taxes and or show any outside circumstances interfering with his efforts to do so. The court also ruled that the Oklahoma statue that Hodges cited does not apply to payroll taxes. The court concluded that none of Hodges arguments amount to reasonable cause and upheld the district court's summary judgment. In conclusion, the court upheld the district court's ruling, noting that Hodges presented no evidence to satisfy the reasonable cause exception. Federal taxes (Social Security, Medicare, Additional Medicare and federal income tax) that are withheld from wages are referred to as "trust fund taxes" because the employer collects them on behalf of employees for payment to the IRS. Accordingly, remittance of trust fund taxes takes priority over all other operating expenses of the business. Section 6672 holds responsible parties personally liable for these trust fund taxes. Particularly as it pertains to Section 6672, arguing that payment of the tax would result in disruption of the business is not generally considered reasonable cause since trust fund taxes are not assets of the business to begin with. Outside of the Section 6672 context, reasonable cause for the failure to file a tax return, make a deposit, or pay tax is achieved if it is determined that the taxpayer exercised ordinary business care and prudence and was nevertheless unable to meet its obligations in a timely manner. (See Treas. Reg. Section 301.6651-1(c).) Ordinary care and prudence is the level of care that reasonably prudent persons would use in conducting their business. According to the IRS Internal Revenue Manual, sound reasons for failing to timely file a tax return, make a deposit, or pay tax include: — Death, serious illness, incapacitation or unavoidable absence of the taxpayer or a member of the taxpayer's immediate family — Other reason which establishes that you used all ordinary business care and prudence to meet your Federal tax obligations but were nevertheless unable to do so Recently, the IRS has routinely denied penalty abatement requests for failure to timely file a tax return, make a deposit, or pay tax based on a strict interpretation of reasonable cause. Taxpayers raising a reasonable cause defense to these types of penalties should affirmatively explain to the IRS why they exercised ordinary business care and prudence and also distinguish unfavorable case-law to the extent possible. For more informal information on the IRS view of what potentially constitutes reasonable cause, see the IRS website. Document ID: 2017-0637 |
