How to Avoid Personal Liability for Unpaid Federal Employee Payroll Taxes

Employer tax
Employer tax

Lessons from an Employee Payroll Tax Withholding (CFO Embezzlement) Case - IRS held the president personally liable for the unpaid taxes

Avoid personal liability for unpaid federal employee payroll taxes. In 2009, the Pittsburgh Post Gazette reported on a story about a woman named Kathleen A. Lawson, who was sentenced to 37 months in prison for failing to report and pay more than $630,000 in federal taxes. Now as a business owner in Central New York, or anywhere else you may be wondering what is the relevance of this story? 

Well because Kathleen A. Lawson, who owned her own business, Wells Cargo Courier Service, also worked full-time as a bookkeeper and CFO for a small business called W.E. Brosius Company. And Timothy McCloskey, who was the president and sole shareholder of Brosius, had trusted and delegated financial responsibilities to her, of which she managed to steal and embezzle over $800,000 from his company. On top of that, Ms. Lawson failed to remit employee withholding taxes to the IRS of $268,377 (she prepared the proper forms and wrote company checks for the payroll taxes due, but then embezzled the money instead) for 19 quarters (4.75 years) from June 30, 2000 through December 31, 2004. 

On September 1, 2004, Ms. Lawson left McCloskey a resignation letter and also confessed to crimes she had done to his company. Upon learning about this terrible fraud and embezzlement, he came to the realization that his company would not be financially able to absorb the losses and stay in business. The company had many debts and creditors that the business owed financial obligations to including the IRS. 

He consulted with his lawyer about his options, but instead of filing for bankruptcy, (he was informed by his attorney that he did not have the necessary assets to do it). The attorney advised McCloskey to begin winding down the business by paying his creditors, his employees, and himself at a reduced rate. McCloskey began paying off creditors; however, he never remitted payment to the IRS for the unpaid trust fund taxes. McCloskey entered into a buy/sell agreement and sold company inventory for $240,000, of which he used those funds to pay off a loan to National City Bank, because he had personally guaranteed this debt. 

On March 1, 2005, Mr. McCloskey, as president of Brosius, signed and mailed Form 941 returns for the 19 back quarters and paid $51,302.14 for the taxes and penalties for three of those back quarters. The remaining assessments against Brosius (and soon, against Mr. McCloskey, individually) for penalties, statutory additions, accrued interest, and costs totaled $325,695. If you own a business you need to understand this is something you will be held responsible for ultimately by the government.  

Case: McCloskey v. U.S., 2:07cv634 Electronic Filing

On September 15, 2009, in a case titled: McCloskey v. U.S., the Plaintiff Timothy McCloskey ("McCloskey") filed this action against the United States of America, seeking a refund of taxes paid toward an assessment entered against him by the Internal Revenue Service ("IRS") for failure to remit $268,377 worth of withholding taxes on behalf of his small private business W.E. Brosius Company ("Brosius"). McCloskey tried to contend that although he was a responsible person within the meaning of 26 U.S.C. § 6672 of the Internal Revenue Code ("IRC"), he did not willfully fail to pay over the withholding taxes and therefore is not personally liable for those taxes. He tried to cite a few cases and arguments which the court did not find merit for them in his defense. The United States filed a counterclaim asserting McCloskey has willfully failed to pay the withholding taxes because after learning of the tax delinquencies he paid more than the amount owed to other creditors before remitting partial payment to the IRS. 

In the end the court ruled the United States' motion for summary judgment requesting liability against McCloskey for the full amount assessed against him must be granted. The court specified that “creditors were paid in full while the IRS was not paid” and that “ McCloskey was a responsible person who willfully failed to pay the IRS and thus is personally liable for the amount owed."

McCloskey vs US

This case was even cited and written about in a book called American Payroll Association (APA) Basic Guide to Payroll, 2016 Edition.

As a business owner, you are personally responsible for making sure that the payroll trust fund taxes are paid even if your CFO embezzled the funds 

If you own and are active in the business, you are personally responsible for making sure that the payroll taxes are paid. Neither the IRS nor the law allows excuses. 

For a more recent example during the past 20 months of the COVID-19 pandemic, some cash-strapped employers may fail to pay over federal income and employment taxes that were withheld from employee paychecks to the U.S. Treasury. In the eyes of the IRS, this is a major tax faux pas — punishable with a whopping 100% penalty against any responsible person.

In other words, the entire unpaid federal payroll tax amount can be assessed as a penalty against a responsible person or several responsible persons. The logic behind the 100% penalty is that the federal government should be able to collect withheld, but unpaid, federal payroll taxes from unscrupulous individuals who had control over an employer’s finances.

Who’s Considered a Responsible Person?

The 100% penalty can be assessed only against a so-called “responsible person.” That could be:

  • A shareholder, director, officer, or employee of a corporation,

  • A partner or employee of a partnership, or

  • A member (owner) or employee of a multi-member limited liability company (LLC).

The 100% penalty can also be assessed against an employee of a sole proprietorship or an employee of a single-member (one owner) LLC. To be hit with the 100% penalty, an individual must meet the following two criteria: 

  1. Be responsible for collecting, accounting for, and paying over withheld federal taxes, and

  2. Willfully fail to pay over those taxes. 

The term “willful” means intentional, deliberate, voluntary and knowing — as opposed to accidental. The mere authority to sign checks when directed to do so by a higher-up doesn’t establish responsible-person status. There must also be knowledge of and control over the finances of the business.

The IRS may look first at individuals who have check-signing authority. However, you can’t deflect responsible-person status by simply assigning signature authority over bank accounts to someone else. 

To determine responsible-person status, the IRS also may consider whether the individual:

  • Is an officer or director,

  • Owns shares or possesses an entrepreneurial stake in the company,

  • Is active in the management of day-to-day affairs of the company,

  • Has the ability to hire and fire employees,

  • Makes decisions regarding which, when, and in what order outstanding debts or taxes will be paid, and

  • Exercises daily control over bank accounts and records of disbursements

See if you can answer the following question: Are you absolutely, positively sure that your payroll tax money has been remitted to the IRS? Have you seen absolute, physical proof with your own eyes?

  • You can’t ask someone and count on that answer. 

  • You can’t see a report from your payroll service and believe that as absolute proof. 

  • The fact that the payroll tax amounts were taken from your business bank account does not mean that money was remitted to the IRS. 

So, as a business owner, what can you do to protect yourself against dishonest employees (such as what happened to McCloskey)? To make sure you are in compliance you can examine your account with the IRS.  It will allow you to see your payroll tax money sitting in your IRS payment account by just looking at your account. 

IRS’s Electronic Federal Tax Payment System (EFTPS)

What you can do is register with the IRS Electronic Federal Tax Payment System (EFTPS). Once registered, you can see physical proof of your tax payments in the IRS register. The register holds the last 15 or 16 months of your payments. 

The EFTPS register is absolute proof. If you see the deposits in the register, you know that your in-house bookkeeper or outside payroll service properly sent the money to the IRS. If the money is missing, the register tells you so. 

As a small business owner, it’s tough to keep up with the latest news in payroll laws, payroll regulations, payroll cases, IRS announcements regarding payroll, Department of Labor pronouncements about wage and hour laws, and payroll trends?  

When you participate in running an organization that hasn’t paid over federal payroll taxes that were withheld from employee paychecks, you run the risk of the IRS classifying you as a responsible person. If that happens, you could personally be assessed a 100% penalty.

Consult your tax advisor about what records you should be keeping and what actions you should be taking (or not taking) to avoid exposure to the 100% penalty.

If you would like to discuss your company’s payroll needs don’t hesitate to contact us for a free consultation or give us a call at 315-361-9696. 

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