For businesses that have achieved any degree of success, the responsibility to account for, collect, hold, and turnover payroll taxes are well known and seemingly a matter of course. As most business owners are aware, payroll taxes are sometimes referred to as trust fund taxes because employers collect and hold certain taxes in trust for the United States government. These withholdings include the FICA and FUTA obligations and can extend to a variety of other purposes.
Unfortunately, it is surprisingly simple for a business and responsible parties to run into issues with the payroll tax when the company runs into difficult financial times or even temporary cash flow issues. Businesses that have not implemented necessary processes and controls may inadvertently engage in payroll tax fraud or otherwise violate its fiduciary or other duties.
Payroll Tax Fraud Can Result in Penalties for Both Company and Responsible Parties
It is essential to note that payroll tax fraud penalties are harsh and can apply not only to the company itself but also individuals who are “responsible parties.” A responsible party could include a bookkeeper, CEO, CFO, manager, owner, or another individual who has control or authority over company payments and financial affairs. When a court finds that payroll tax fraud has occurred, responsible parties can be held jointly and severally liable for the unpaid taxes, penalties, and interest.
Payroll Tax Problems Can Arise Seemingly Overnight When Controls Are Not in Place
A recent bankruptcy proceeding shows just how easy it is for even a well-meaning business owner to run into payroll tax problems. In the case of U.S. Dept. of Labor v. Harris (2017 WL65392), a manufacturing firm CEO eventually found himself in bankruptcy court due to downturns in the company business. In 2008, the company was late with employee insurance payments 10 times. The source of the insurance premium payments were payroll deductions held in trust by the company.
After several months of bounced checks and unpaid premiums, the insurer notified the company that employee insurance coverage would be canceled if the company’s accounts were not brought up to date. Upon learning of this fact, the company requested additional time to pay but this request was denied. At the time of the request for additional time to pay, the company owed about $55,000 in unpaid premiums and had roughly $70,000 in its operating accounts.
However, rather than utilize the funds in the operating account to pay off the insurance debts and maintain insurance coverage for employees, the company paid down other debts. This included paying down roughly $25,000 in personal debts held by the CEO. With the insurance premiums left unpaid, the insurance coverage for the employees was canceled. Shortly thereafter, the CEO resigned and the company was liquidated as part of a bankruptcy proceeding.
Insurance Debt Was Non-Dischargeable in Bankruptcy and Constituted Fraud and Defalcation
In court proceedings regarding whether the CEO could discharge, eliminate, the debt through bankruptcy, the court analyzed three questions:
- Did a trust res exist?
- If a trust existed, did the CEO owe a fiduciary duty in regard to the trust?
- Was defalcation committed when paying other expenses before trust obligations?
To the first questions, the court found that a trust res did exist. The employee wages became plan assets on the date where they were withheld from the employee’s paycheck. The court found that the CEO did have fiduciary duties to the employees because he had ultimate authority regarding which bills would be paid. The court then assessed whether defalcation – the misappropriate of trust fund assets — had occurred. As to this question, the court found that the fact the company could have paid the debt but did not and favored personal and other expenses did constitute defalcation. As such and as a responsible party, the CEO remained liable for the debt since fraud makes it non-dischargeable.
Payroll Tax Issues Are Easy to Encounter When Processes and Controls Are Not in Place
Most companies with employees will engage in some form of payroll withholding. When withholdings are placed into a general operating account, it can be particularly easy to lose sight of the purpose of the funds. When the company is facing financial stress and looking for every available dollar to maintain cash flow, this type of mistake is even easier to make. Unfortunately, serious consequences can attach when a business or responsible party engages in payroll tax fraud.
If you are concerned that your business is not properly handling payroll tax, the tax lawyers of the Tax Law Offices of David W. Klasing may be able to assist. We can assess existing internal controls and make recommendations regarding gaps or oversights in the process. If you suspect already existing payroll tax problems, we can determine your compliance status. If mistakes or errors are found, we can set forth an actionable plan to achieve compliance. We can also help you meet the challenge of a payroll tax audit by the IRS or a California state tax agency. To schedule a confidential reduced rate consultation, please call 800-681-1295 today.
