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Nursing Home Manager Liable for Penalties for Failing to Pay Over Payroll Taxes

(Parker Tax Publishing April 2017)

A nursing home manager was liable under Code Sec. 6672 for the employee withholding taxes he willfully failed to pay over to the IRS. His claims that he used all available funds to rescue nursing home patients from horrific conditions and to avoid having to lay off hundreds of employees did not meet the reasonable cause exception. U.S. v. Hodges, 2017 PTC 167 (10th Cir. 2017).


In 2000, the Oklahoma Department of Health appointed Rex Hodges as the temporary manager of four nursing homes. Under Oklahoma law, the Oklahoma Department of Health has the power to place a qualified person in a nursing home facility as a temporary manager if conditions at the facility pose an immediate threat to residents' health and safety. As the manager, Hodges was responsible for depositing the employees' payroll tax withholdings with the IRS and filing payroll tax returns. Hodges paid the nursing homes' operating expenses and net payroll. He also paid himself a salary of $22,000 per month. Although the payroll processor sent him biweekly reports detailing the amounts withheld from employees' paychecks and instructions for making the deposits with the IRS, Hodges failed to pay the employees' withheld payroll taxes to the IRS. He was removed as temporary manager of the four nursing homes in early 2001. Later in 2001, Hodges decided to invest in his own nursing home. He and a former coworker formed Sand Springs Care Center LLC (Sand Springs). Hodges was named manager and his role was similar to his role as the temporary manager of the four nursing homes and included the same powers and responsibilities. Hodges paid Sand Springs' operating expenses and net payroll, and paid himself a salary, but once again failed to remit payroll taxes that had been withheld from employees' salaries.

The IRS determined that Hodges was a responsible person under Code Sec. 6672 who willfully failed to pay over taxes withheld from employees' paychecks. In 2004, the IRS began assessing penalties against Hodges for the unpaid payroll taxes which accrued both during his time as temporary manager of the four nursing homes and as manager of Sand Springs. In February 2004, federal tax liens attached to property Hodges owned as a joint tenant with his wife. In April 2004, Hodges transferred his interest in the property to his wife. The IRS continued assessing penalties and liens continued to attach to the property after the transfer. Hodges' wife received a notice of lien in 2015. She was identified as her husband's nominee or recipient of a fraudulent transfer.

Before a district court, the IRS moved for summary judgment on its assessments and to enforce the liens on the property. Hodges argued that he relied on others to pay the payroll taxes. Thus, he claimed he had reasonable cause for failing to pay over the taxes and should not be liable for the penalties. Hodges' wife argued that her due process rights had been violated because she was denied a Collection Due Process (CDP) hearing. She also denied she had received her husband's interest in the property through fraudulent transfer or as his nominee.

District Court's Decision

The district court sided with the IRS, finding no evidence to support Hodges' reasonable cause argument. A judgment was entered against Hodges for approximately $1.9 million. The district court also granted partial summary judgment with respect to pre-transfer liens of approximately $329,000. Finally, the district court rejected the motion by Hodges' wife to dismiss. It concluded that she did not dispute the validity of the pre-transfer liens, and that those were the only ones the government sought to enforce with summary judgment.

The district court found it premature to consider whether Hodges' wife took the property as Hodges' nominee or whether she was unfairly denied a hearing because those issues applied only to the post-transfer liens. The district court entered an order of sale, then approved a settlement between the parties under which the property would be sold to Hodges' wife and the IRS would discharge all liens on the property arising from assessments against Hodges.

Appeal to the Tenth Circuit

Hodges appealed to the Tenth Circuit, arguing that (1) the IRS wrongfully assessed penalties under Code Sec. 6672 on him because he did not act willfully in failing to pay over the taxes, and (2) the district court erred in ordering foreclosure on the property and in denying Hodges' wife's motion to dismiss because her right to a CDP hearing had been denied.

Under Code Sec. 6672, a person who is responsible for collecting and paying over employee withholding tax is liable for the amount of any tax the person willfully fails to collect and pay over. However, if the person has reasonable cause for failing to pay withholding taxes, then the failure is not willful, and the person is not liable. The reasonable cause exception, articulated in Finley v. U.S. 123 F.3d 1342 (10th Cir. 1997), applies if (1) the taxpayer made reasonable efforts to protect the funds held in trust for the government, and (2) those efforts were frustrated by circumstances outside of the taxpayer's control.

Hodges made three arguments as to why the reasonable cause exception applied. First, he said, there was an urgent necessity to rescue the nursing home residents from the horrific conditions that existed when he became temporary manager of the four nursing homes and he "naively" put all available funds toward rehabilitation of the facilities and care of the residents. He claimed that he would have had to close the nursing homes and that hundreds of employees would have been let go if he had paid over the taxes. Second, he claimed that the owner of three of the four facilities, Gary Kading, promised that he would pay for all rehabilitation expenses, which Hodges understood to include payroll taxes. Finally, Hodges argued that he relied on an Oklahoma statute that was cited in the order appointing him as temporary manager and which says that if funds are insufficient to meet the expenses of performing the powers and duties conferred on the temporary manager, the temporary manager may borrow the funds or contract for indebtedness as necessary. The Tenth Circuit rejected all three arguments.

Reasonable Cause Exception Did Not Apply

First, the Tenth Circuit found that Hodges did not make reasonable efforts to protect the withheld taxes and that the financial condition of the nursing homes did not constitute circumstances outside of his control. Hodges did not, in the court's view, show any evidence that he tried to protect the withheld taxes. Rather, he admitted he voluntarily and intentionally chose to pay operating expenses, including employees' net wages, his own salary, and other creditors, before paying over the taxes. The financial concerns Hodges described were not circumstances outside of Hodges' control. The court noted that virtually every Code Sec. 6672 violation arises because a business is in financial straits. The financial condition of the nursing homes was therefore not sufficient to qualify Hodges for the reasonable cause exception.

The court also rejected Hodges' argument that he had relied on a promise by Kading to pay for all rehabilitation expenses. First, the court noted that a similar argument had been rejected in a prior Tenth Circuit decision, Denbo vs. U.S., 988 F.2d 1029 (10th Cir. 1993). Hodges, the court said, was guilty of willfully failing to remit the withheld taxes because he knew the nursing homes were not paying over the taxes, and he bore responsibility for making these payments. The court said that he could not now claim that he relied on Kading's promise to pay rehabilitation expenses as justification for not remitting the payroll taxes to the IRS. Hodges knew the taxes were not being paid over and nothing in Kading's promise to pay rehabilitation expenses suggested otherwise. The court also noted that even if Hodges had relied on Kading's promise, Kading was not involved with the fourth nursing home or with the Sand Springs home, so Hodges could not claim that his failure to pay over taxes with respect to those facilities had anything to do with Kading's promise. The court concluded that Hodges made no effort to pay the taxes, showed no outside circumstances interfering with his efforts to do so, and that Kading's alleged promise fell far short of evidence that Hodges had attempted to protect the funds but was frustrated in his efforts.

Finally, the court rejected Hodges' argument that he had reasonable cause because of the Oklahoma statute that he cited. The court found that the statute said nothing about taxes and did not attempt to preempt Code Sec. 6672. The statute did not, in the court's view, immunize a responsible person from Code Sec. 6672 liability when that person had the withholding taxes available to pay the IRS but failed to do.

Liens Were Valid

The court also rejected arguments made by Hodges and his wife regarding the validity of the liens on their property. Hodges argued that when he transferred his interest to his wife, she took the property without notice of the pre-transfer liens, and that she therefore took his interest free of that liability. The court disagreed and found that under Code Sec. 6322, the liens survived the transfer.

The court also was not persuaded by arguments that Hodges' wife was denied due process by not receiving a CDP hearing and that she did not receive the property by fraudulent transfer or as her husband's nominee. After the district court granted summary judgment on the pre-transfer liens, the liens were discharged and the IRS waived any claims that Hodges's wife took the property as nominee or as fraudulent transferee, so those issues were moot, as were the issues relating to the CDP hearing.

For a discussion of the penalty for failing remit payroll taxes, 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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