New York Tax Law §685(g) contains a virtually verbatim provision for New York’s personal income tax withholdings, and New York Tax Law §1133(a) similarly but somewhat more laconically imposes personal liability upon those required to collect the sales and use taxes. Personal liability for New York City taxes that are or should be collected is likewise imposed under the New York City Administrative Code, including NYCAC §11-1775 for the personal income tax on city residents, §11-1913 for the nonresident earnings tax, and §11-2016 for city sales and use taxes. The duty to make payment to the government arises at the instant wages are paid and/or taxes are withheld.2
Federal case law is applied to interpret and construe the New York statutes.3 One can be saddled with simultaneous liability for state and federal trust fund taxes; moreover, an IRS administrative finding that the individual was not a responsible person for federal tax purposes does not necessarily preordain a similar finding by the New York State Department of Taxation and Finance (or for that matter, the New York City Department of Finance).4
Factors weighed in determining whether an individual is a responsible party include, but are not limited to, whether and to what extent the individual
All responsible parties who cannot show that they did not willfully cause the tax deficiency are jointly and severally liable to the IRS for the entire deficiency, without regard to the relative degree of fault.6
The term “willfully” as used in the statute establishes a low threshold. The responsible person who intentionally and knowingly makes payments to creditors other than the IRS while the trust fund taxes remain unremitted acts “willfully” and is liable under the statute.
No venal or nefarious motive is necessary.7 It is no excuse that a bank or other lender insists that other debts be paid instead of the tax obligation,8 nor that the responsible person might risk job loss9 or criminal prosecution10 for failure to apply the employer’s funds towards the other obligations.
Accordingly, paying normal business costs and expenses such as wages and supplies, when such expenditures leave the government with less than its due, will make one answerable under IRC §6672. It is irrelevant that the business might not survive as a going concern if such other creditors are not paid. “The government cannot be made an unwilling partner in a floundering business.”11
Trust Fund Tax Liability
IRC §6672 is a harsh statute, and sweeps broadly and inclusively, not only in the actions (or inactions) that come within its ambit of liability, but also in its administration. The IRS has broad discretion to pursue any or all of the responsible parties of its choosing, without regard to relative degree of fault,12 and likewise has broad discretion to settle with responsible parties on terms of its choosing.13 The New York State taxation authorities have equally broad discretion.14
The wide territory encompassed by the trust fund liability statutes cannot be overestimated. Even payment of analogous state employment taxes while federal trust fund taxes remain due and owing constitutes preference of a creditor other than the government.15 Likewise, paying wages to the employees, with nothing remaining to remit to the IRS, constitutes preferring the employee over the IRS.
The Sorenson v. United States decision from the U.S. Court of Appeals for the Ninth Circuit provides explicit guidance for those in cash-strapped companies who are compelled to navigate the treacherous waters of the trust fund statutes:
The proper course for those, such as Sorenson, who have scarce resources is to prorate such funds as are available between the Government and the employees. Thus, assuming a withholding obligation of 10% on gross wages, a net wage obligation of $100, and $100 in available funds, the employer may not pay $100 in net wages. He can only pay $100 in gross wages, consisting of $90 in net wages and $10 in withholding on behalf of the Government. The wage earners, thus, would continue to have a gross wage claim of approximately $11.11 while all accrued claims of the United States would have been satisfied. Upon payment of this balance of the wage claim, tax in the amount of $1.11 would be due the United States.16
In New York and other jurisdictions where both state and federal taxes are required to be withheld, the proration mechanics described in Sorenson must include federal, city and state tax obligations (including Workers’ Compensation).
Although there is no general requirement to segregate the trust funds in a separate account pending remittance of such funds to the government (unless the IRS, pursuant to IRC §7512, specifically demands it), such a prophylactic measure nonetheless might be advisable for the cash-strapped employer.
Notably, where the delinquent business is a partnership, all partners are jointly and severally liable for the trust fund taxes by dint of their status as such, without regard to §6672 behavior. The taxation authorities are not reticent to impose trust fund liability under a partnership by estoppel theory.17
Lawyer Liability Concerns
The usual duty of care obviously applies to the lawyer who advises a client regarding trust fund issues. Additionally, certain lawyer liability issues are particularly relevant to trust fund cases. The liability of the business and all of its responsible parties is, in totality, a zero-sum game, that is, payment of any part of the deficiency from any source correspondingly reduces the liability of the remaining responsible parties.
Accordingly, where there exists anything in the nature of a lawyer-client relationship with more than one responsible party, there is great potential for the lawyer to find himself or herself in a conflict of interest situation, particularly where the lawyer is aware of the tax deficiency.18 And, of course, the lawyer who is an officer or director of the corporation he or she advises might face potential trust fund liability in addition to whatever legal malpractice concerns may arise.19
In matrimonial law situations involving a family business, counsel should be mindful of the trust fund liability issues, and attend to all formalities required to sever their client’s responsibilities for trust fund taxes, else the issue may resurrect following what the client believed was a final disposition of the marital assets,20 thereby inviting a malpractice action.
Recessionary economic climates inevitably place many businesses in situations where current obligations significantly exceed available dollars. Some actions required to avoid personal liability for trust fund tax obligations of a cash-crunched business may appear counterintuitive to prudent business judgment (and indeed, may well impair the business’ relationships with its suppliers and/or customers).
Many have been ensnared in the trust fund tax trap set by IRC §6672 and the state and city statutes, and many more can be expected to be similarly tagged with personal tax liability for employment taxes, sales taxes, and other governmental exactions that remain unpaid by stumbling business entities in an insecure economic atmosphere such as the one now prevailing.
Though, subsequent to exaction of the funds by the IRS, the party unfortunate enough to have been caught in the tax collector’s clutches may bring an action for contribution against his or her fellow bunglers,21 it is far cheaper, simpler, and preferable to avoid a trust fund tax deficiency situation from arising at all than to mitigate the damage it might wreak.
The competently advised client can minimize his or her exposure to personal liability under the trust fund liability statutes. Attorneys and accountants who advise clients to take any course of action that shorts the government on its trust fund collections may well be called upon to help underwrite the extraction of their erstwhile clients from trust fund tax liability obligations.
Kenneth H. Ryesky, a solo practitioner, teaches courses in business law and in taxation at Queens College CUNY. He formerly served as an attorney for the Internal Revenue Service.
Endnotes:
1. IRC §7501(a).
2. Teel v. United States, 529 F.2d 903, 906 (9th Cir. 1976).
3. Levin v. Gallman, 42 N.Y.2d 32, 364 N.E.2d 1316, 396 N.Y.S.2d 623 (1977); Yellin v. State Tax Commission, 81 A.D.2d 196, 440 N.Y.S.2d 382, (3d Dept. 1981).
4. Matter of Wendel, NYS Tax Appeals Tribunal, DTA 816152 (Feb. 3, 2000).
5. Fiataruolo v. United States, 8 F.3d 930, 939 (2d Cir. 1993).
6. E.g., Howard v. United States, 711 F.2d 729, 737 (5th Cir. 1983); Gephart v. United States, 818 F.2d 469, 476 (6th Cir. 1987).
7. Bloom v. United States, 272 F.2d 215, 223 (9th Cir. 1960); cert. denied, 363 U.S. 803 (1963).
8. E.g. Kalb v. United States, 505 F.2d 506, 510 (2d Cir. 1974), cert. denied, 421 U.S. 979 (1975); Bradshaw v. United States, 83 F.3d 1175 (10th Cir. 1996).
9. Hochstein v. United States, 900 F.2d 543, 549 (2d Cir. 1990).
10. Brown v. United States, 591 F.2d 1136, 1141 (5th Cir. 1979).
11. Collins v. United States, 848 F.2d 740, 741-742 (6th Cir. 1988).
12. United States v. Pomponio, 635 F.2d 293 (4th Cir. 1980); Kelly v. Lethert, 362 F.2d 629, 635 (8th Cir. 1966).
13. IRS v. Blais, 612 F.Supp. 700 (Dist. Mass. 1985).
14. See Matter of Haseley Trucking Co. Inc., NYS Div. of Tax Appeals, DTA 819672 (April 28, 2005); Matter of Tobias Gold, NYS Tax Comm., File No. 15704 (March 25, 1974).
15. See Anuforo v. Commissioner, 2009 U.S. Dist. LEXIS 26667 at 11 (Dist. Minn., 2009).
16. Sorenson v. United States, 521 F.2d 325, 328 (9th Cir. 1975).
17. See Matter of Himed Deli Corp., NYS Tax Appeals Tribunal, DTA 814493 (March 30, 2000).
18. McDermitt v. United States, 1991 U.S. Dist. LEXIS 1698 at 5 (S.D. Ohio 1991), aff’d 954 F.2d 1245 (6th Cir. 1992).
19. See Davis v. United States, 2008 U.S. Dist. LEXIS 80918 (W.D. La. 2008).
20. See Matter of Toomer, NYS Tax Appeals Tribunal, DTA 818485 (14 Aug. 2003).
21. IRC §6672(d).
