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Co-owner Liable for Employment Taxes Not Paid by Other Co-owner

(Parker Tax Publishing August 2017)

A district court held that a corporation's 50-percent owner was liable for trust fund penalties relating to employment taxes that went unpaid. While the other 50-percent owner was responsible for preparing and paying the employment taxes, the court found that the taxpayer exercised enough influence and control over the company's financial affairs to be held liable. U.S. v. Hartman, 2017 PTC 343 (E.D. Mich. 2017).


Jon Hartman was the 50 percent co-owner and Chief Executive Officer of Spectrum Tool & Design, Inc., while the company operated from April 2001 to October 2005. Dan Ott was 50 percent co-owner and Chief Operating Officer from April 2001 until Hartman laid him off in August 2005. Both Hartman and Ott had authority to handle money for Spectrum, open and close bank accounts in its name, and sign checks. Generally, Hartman signed employees' paychecks, whereas Ott prepared the payroll tax deposit checks. Until December 2003, Spectrum used a third-party payroll service provider, ADP, to process its paychecks.

In December 2003, Spectrum was unable to pay the full amount of gross payroll

(including taxes) due to ADP, and ADP terminated the contract. Spectrum was

able to pay employees their net payroll during this period, meaning that Spectrum was unable to remit the gross payroll due to its inability to remit the payroll tax portion. Hartman admitted that he knew, in December 2003, that Spectrum could not timely pay its payroll taxes, but said that he and Ott anticipated that they would be able to pay back the shortfall in January or February 2004. After being dropped by ADP, Spectrum began using an in-house software system for handling payroll, at Ott's behest.

According to Hartman, he did not learn that Ott was routinely failing to pay the payroll taxes until July 2004 - at which time he arranged a meeting with the IRS to discuss the shortfalls. Hartman described independently discovering accounting irregularities in the in-house software; getting "nosy," and going through Ott's desk, where he discovered that Ott had not been paying the taxes. Up until that point, Hartman claimed that Ott was creating payroll tax checks regularly, leading Hartman to think Ott was paying those. According to Hartman, at the first IRS meeting the IRS told him to focus on staying current and then "try to get the back ones caught up." Spectrum could not stay current, however, necessitating another meeting with the IRS in October 2004. At the October 2004 meeting, Hartman discovered that Ott had not been keeping up with Spectrum's current taxes.

At that meeting with the IRS, Hartman signed Forms 941 for quarterly periods ending December 31, 2003 through September 30, 2004. Those returns reflected employment taxes that had not been paid. In May 2005, an IRS Revenue Officer interviewed Hartman. The interview was documented on a Form 4180, which Hartman signed, acknowledging that he examined the information on the form and that it was true. On the form, Hartman admitted, among other things, that he determined financial policy for the business; directed or authorized the payment of bills; authorized or signed payroll checks; and authorized or made federal tax deposits. He indicated that he did not prepare, review, sign, or transmit payroll tax returns. On the Form 4180, Hartman also admitted that while the delinquent taxes were increasing, he authorized the payment of certain of Spectrum's other financial obligations, including payroll, utilities, rent, supplies, operating expenses, loan payments, and equipment leases.

Hartman fired Ott in August 2005 for performance issues. However, even after firing Ott, Hartman still used Ott to pay Spectrum's employment taxes. Following an investigation, the IRS assessed trust fund liabilities against Hartman and petitioned a district court for summary judgment against Hartman. In his defense, Hartman argued that he was unaware of the deficiencies until after the fact and that it was Ott's job to handle the taxes.

Liability for Trust Fund Penalties

Code Sec. 6671 imposes personal liability on a corporate officers who is under a duty to pay wrongfully diverted taxes. Under Code Sec. 6672, the government must prove that a person was responsible for paying the taxes and willfully failed to pay the taxes due.

In Kinnie v. U.S., 994 F.2d 279 (6th Cir. 1993), the Sixth Circuit, the circuit to which the decision in the instant case would be appealable, held that whether one is considered a person responsible for paying over employment taxes to the government under Code Sec. 6672 is a question focusing upon the degree of influence and control which the person exercised over the financial affairs of the corporation, and, specifically, disbursements of funds and the priority of payments to creditors.

In Kinnie, a 50 percent owner and vice president of a company tried to invoke his status as a passive investor, in arguing that he was not a "responsible person" under Code Sec. 6672. The Sixth Circuit rejected this argument, noting that the vice president was a 50 percent shareholder during all the quarters that the company failed to pay withholding taxes, had authority to sign checks, had an accountant review the books for possible diversion of corporate funds and had forced the president to leave the corporation and ultimately shut down the corporation. The Sixth Circuit rejected the taxpayer's defense that he had "delegated" the duty to pay the taxes to the president, stating that there may be more than one person deemed a responsible person within a corporation and one who possesses significant control over the company's financial affairs may not escape liability by delegating the task of paying over the taxes to someone else. Moreover, the Kinnie court held that liability requires the existence of only significant as opposed to absolute control of the corporation's finances.

District Court's Ruling

Citing the Sixth Circuit's decision in Kinnie, the district court held that Hartman was a responsible person with respect to the employment taxes at issue. While Hartman had no responsibilities related to calculating or paying the payroll taxes and Ott maintained this duty even after he was laid off in May 2005, the district court said it was undisputed that Hartman had the authority to pay the payroll taxes if he wished to do so. The court found that every single basis for finding the taxpayer in Kinnie to be a "responsible person" was present. The court noted that Hartman possessed the same title, ownership interest, check-writing authority, and ability to force his coowner out of the business as the taxpayer in Kinnie did. And, just as the taxpayer in Kinnie was able to commission an inspection of the books to see if his partner was misappropriating funds, Hartman initiated meetings with the IRS upon discovering that the accounting balances didn't add up. In fact, the district court observed, Hartman had more responsibility and involvement than the taxpayer in Kinnie.

With respect to the issue of willfulness, the court agreed with the government that Hartman recklessly disregarded a known or obvious risk that employment taxes were not being paid. The court cited the decision in In re Premo, 116 B.R. 515 (Bankr. E.D. Mich. 1990), where a bankruptcy court surveyed three typical scenarios in which a finding of willfulness can be based on reckless disregard. The district court found two of those to be particularly apt in Hartman's case. First, courts have held that reliance upon the statements of a person in control of the finances of a company (in this case, Ott) may constitute reckless disregard when the circumstances show that the responsible person (i.e., Hartman) knew that the person making the statements was unreliable. Second, the district court said, courts have held that willful conduct also includes failure to investigate or to correct mismanagement after having noticed that withholding taxes have not been remitted to the government.

For a discussion of responsible person liability, see Parker Tax ¶210,108.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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