By: Dean Langdon
As a business owner, you probably know you can be personally liable if federal employment taxes aren’t paid. But just being a business owner doesn’t mean you are automatically responsible. For federal withholding taxes you must be a person who is required to remit the taxes and “willfully” fail to pay them in order to be held personally liable. So, what does it mean to “willfully” fail to pay taxes? Can ignorance protect you?
On July 26, 2018 the Sixth Circuit Court of Appeals (which covers Kentucky, Ohio, Michigan and Tennessee) issued a ruling which helps define what “willfully” means. In United States of America v. Jon R. Hartman (Case No. 17-2273) the Court of Appeals affirmed a district court decision finding Hartman responsible for unpaid withholding taxes of a co-owned business. What led to Mr. Hartman being held responsible for the unpaid taxes?
Mr. Hartman co-founded a business with Mr. Ott, who was handling the payroll and employment tax aspect of the business. The business initially used an outside payroll processor, but when the business couldn’t make payroll in December, 2003, the payroll processor exited stage left. Hartman delegated responsibility for payroll to Ott, although Hartman continued to sign checks for the business. In July, 2004, Hartman found checks payable to the IRS in Ott’s desk and confirmed with the IRS that the business had not been paying withholding taxes. An IRS agent told Hartman the company should start paying its taxes and make up the difference over time. However, in October, 2004, the IRS agent told Hartman that the business was still not paying its current taxes.
Hartman did not remove Ott from payroll duties, and relied on entries in their accounting software to determine if taxes were being paid. Hartman eventually realized the business could not pay the taxes, and the business filed a Chapter 11 bankruptcy in January, 2005. Guess who remained in charge of paying taxes during the bankruptcy?
The business also failed to pay employment taxes during the bankruptcy case, but Hartman did not replace Ott or review the payroll tax situation. In July, 2005 the business hired a company to handle its billing and collections and designate 10% to pay unpaid taxes. That didn’t work either, and the bankruptcy converted to a Chapter 7 liquidation in October, 2005. Hartman had fired Ott in August, 2005, but kept him in charge of the payroll even afterwards. After the dust died down, the IRS sued Hartman to recover unpaid payroll taxes for the 4th quarter of 2004 and all of 2005, and the district court granted summary judgment to the IRS.
On appeal, the Court of Appeals defined “willfully” failing to pay taxes as either knowing the taxes were not paid or “deliberately or recklessly” ignoring facts and risks that they were not paid. Upon reviewing what Hartman knew and when he knew it, the Court of Appeals determined that Hartman acted willfully because he continued to believe Ott was paying the taxes when he had no plausible basis for that belief.
The lesson for business owners is that just delegating responsibility for payroll taxes isn’t protection from liability. Once you are aware employment taxes haven’t been paid, you should take steps to make sure they are paid going forward (like getting a new person to handle the task) and verify that the taxes are actually being paid (not just entered into an accounting system). The IRS isn’t in the business of making loans, and if your business can’t afford to pay payroll taxes, there are probably other financial issues at play. DelCotto Law Group helps businesses through times of financial distress (including failing to pay payroll taxes). Let us know if we can help.
DelCotto Law Group is Kentucky’s asset protection law firm known for its commitment to the lifetime success of its clients. With offices located in Lexington, Louisville and Danville, DLG serves Kentuckians with complicated financial matters, especially in the areas of bankruptcy, complex litigation, and estate planning. For more information about filing bankruptcy or DelCotto Law Group, please call (859) 231-5800 or email [email protected].