Archive for category: Criminal Tax Prosecutions

The assessment of the § 6672 penalty can be devastating, and in some cases, life changing. Individuals who are subject to the penalty usually state that they were unaware that failure to collect and pay employment taxes to the IRS could result in personal liability for unpaid payroll taxes, and in certain cases, criminal prosecution. The recent increase in the number of employment tax examinations and criminal prosecutions is alarming and certainly underscores the Government’s commitment to making employment tax fraud a priority.

The § 6672  penalty, commonly known as the “Trust Fund Recovery Penalty” (“TFRP”) imposes personal liability on individuals who are required to collect,  account for, and pay over employment taxes and who willfully fail to collect such tax, or truthfully account for and pay over such tax. The requirements for imposition of the penalty are: (1) the penalized person is deemed to be a “responsible person” or someone responsible for having collected and paid the tax in the first place; and (2) the penalized person must have willfully failed to collect and pay that tax. Godfrey v. United States, 748 F.2d 1568, 1574 (Fed. Cir. 1984).  The TFRP provides the IRS with an alternate means of collecting unpaid employment taxes, when the employer is unable to do so, by permitting the IRS to pierce the corporate veil and hold those responsible for the employer’s failure to pay the outstanding taxes. White v. United States, 372 F.2d 513, 516, 178 Ct.Cl. 765 (1967).

The TFRP usually comes into play when a business is experiencing a financial crisis and the owner elects to use the available funds to pay other creditors, such as a bank or a supplier. In more egregious cases the responsible person may use the trust funds for personal expenses or to support an extravagant lifestyle.

Employers are required to withhold income and FICA taxes from employee salaries and must also contribute the employer’s share of FICA taxes. The withheld funds are to be placed in trust with the government designated as the beneficiary.

The IRS commitment to pursue those who have failed to account and deposit payroll taxes on behalf of their employees is underscored by the remarks made by the Assistant Attorney General at a Federal Bar Association Conference:

“Since January 2015, the Tax Division has sharpened its focus on civil and criminal employment tax enforcement.  As most of you know, these cases involve employers who fail to collect, account for, and deposit tax withheld from employee wages.  These withholdings represent 70 percent of all revenue collected by the IRS, and as of September 2015, more than $59 billion of tax reported on Forms 941 remained unpaid.  These employers are literally stealing money, knowing that their employees will receive full credit for those amounts when they file their returns.  The employers gain an unfair advantage over their competitors and the U.S. Treasury is left holding the bag.” Acting Assistant Attorney General Remarks at Federal Bar Association Tax Law Conference (March 4, 2016).

26 U.S.C § 6672 (a) provides in part:

“Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.”

The assessment of the TRFP requires that the IRS establish that the person against whom enforcement is sought had a duty to collect, account and pay over employment taxes.

The term “person” is defined in 26 U.S.C. § 6671(b) and includes:

“an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee, or member is under a duty to perform the act in respect of which the violation occurs.”

The courts use the term “person” and “responsible person” interchangeably. While the term “person” is statutorily defined, the latter is not. Rather, the term “responsible person” is a creation of the courts. Slodov v United States, 436 U.S. 238 – Supreme Court 1978.  In order to be considered a responsible person, the taxpayer must be “under a duty” to collect, truthfully account for, and pay over” any taxes. The inquiry will always focus on whether the person has “significant control over the enterprise’s finances.” Fiataruolo v. United States, 8 F.3d 930, 939 (2d Cir. 1993) (quoting Hochstein v. United States, 900 F.2d 543, 547 (2d Cir. 1990)).

While many of the cases involve officers, directors and shareholders, the courts have expanded who qualifies as a responsible person to include creditors, employees, accountants and attorneys.  If the responsible person could have impeded the cash flow of the business to prevent the trust funds from being squandered, then he or she will be held liable Thomas v. United States, 41 F.3d 1109, 1113 (7th Cir. 1994). Furthermore, the TFRP can be assessed against more than one person. Thibodeau v. United States 828 F.2d 1499, 1503 (11th Cir. 1987). Consequently, each person found liable can be held responsible for the full amount of unpaid trust fund taxes.

The IRS considers the following factors when making a determination of whether a person is a responsible person:

1. Does the person(s) have a duty to perform?
2. Does the person(s) have the power to direct the act of collecting trust fund taxes?
3. Does the person(s) have the accountability for and authority to pay trust fund taxes?
4. Does the person(s) have the authority to determine which creditors will or will not be paid?
5. Does the person(s) have the status, duty and authority to ensure that the trust fund taxes are paid?
6. Is the person(s) an officer, director, or shareholder of the corporation?
7. If the person(s) is an officer, what do the corporate by-laws state regarding the person(s) responsibilities as it relates to financial matters?
8. Does the person(s) have the ability to sign checks?
9. Does the person have the authority to hire and fire employees?
10. Does the person have the authority to sign and file the excise tax or employment tax returns, such as Form 941, Employer’s Quarterly Federal Tax Return?
11. Does the person control payroll/disbursements?
12. Does the person control the corporation’s voting stock? and
13. Does the person(s) make federal tax deposits?

While no one factor is dispositive, check-signing authority is considered strong indicia of responsibility, even in cases where the check signer is instructed by a superior not to pay the taxes.  Howard v. United States, 711 F.2d 729, 734 (5th Cir. 1983). The facts in each case are evaluated by the IRS when making a determination as to responsibility. As the Court of Appeals pointed out in Godfrey:

“. . . the case law makes abundantly clear, a person’s “duty” under § 6672 must be viewed in light of his power to compel or prohibit the allocation of corporate funds. It is a test of substance, not form.” Godfrey 748 F.2d at 1576.

In addition to establishing that the individual is a “responsible person”, it is necessary that the Government prove that the person acted willfully.  The Internal Revenue Manual defines “willfulness” in the context of the TRFP as:

“intentional, deliberate, voluntary, and knowing, as distinguished from accidental. Willfulness is the attitude of a responsible person who with free will or choice either intentionally disregards the law or is plainly indifferent to its requirements.” I.R.M. § 8.25.1.3.2

Some of the factors the I.R.S will consider in making a determination of whether a responsible person was willful include:

• Whether the responsible person had knowledge of a pattern of noncompliance at the time the delinquencies were accruing;
• Whether the responsible person had received prior IRS notices indicating that employment tax returns have not been filed, or are inaccurate, or that employment taxes have not been paid;
• The actions the responsible party has taken to ensure its Federal employment tax obligations have been met after becoming aware of the tax delinquencies; and
• Whether fraud or deception was used to conceal the nonpayment of tax from detection by the responsible person. Id.

The courts have construed “willfulness” under § 6672 to mean the “voluntary, conscious and intentional act” of paying creditors other than the IRS when the company is financially troubled. Phillips v. IRS, 73 F.3d 939, 942 (9th Cir. 1996) (quoting Davis v. United States, 961 F.2d  867, 871 (9th Cir. 1992); Klotz v. United States, 602 F.2d 920, 923 (9th Cir. 1979)).

While evidence of willfulness requires proof of a voluntary, intentional, and conscious decision not to collect and remit taxes thought to be owing, it does not require proof of a special intent to defraud or deprive the Government of monies withheld on its account. Godfrey 748 F.2d at 1576, citing Scott v. United States, 354 F.2d at 295. The Court of Claims has consistently rejected the view that “a finding of willfulness entails a showing of evil motive, bad purpose, or calculated malevolence.” Id. at 1576. The focus of inquiry is rather “on the deliberate nature of the individual’s election not to pay over the money and the circumstances of that refusal.” Id. at 1576.  Consequently, if a person deemed a responsible party discovers that there are unpaid taxes, the responsible person has an immediate duty to use all unencumbered funds to pay taxes. United States v. Kim, 111 F.3d 1351, 1357 (7th Cir. 1997). Failure to pay the back taxes will result in personal liability on the part of the responsible person.

The Court of Appeals in Godfrey echoed the White definition of willfulness as meaning “a deliberate choice voluntarily, consciously, and intentionally made to pay other creditors instead of paying the Government.” Godfrey 748 F.2d at 1577, citing Scott 372 F.2d at 521. The Court of Appeals citing Feist v. United States, 607 F.2d at 961 also noted that willful conduct may also include a reckless disregard of an “obvious and known risk” that taxes might not be remitted. Finally, the Godfrey Court citing Bauer v. United States, 543 F.2d at 150; stated: “Mere negligence in failing to ascertain facts regarding a tax delinquency,” however, “is insufficient to constitute willfulness under the code.” Godfrey 748 F.2d at 1577.

When an employer falls behind on the payment of its payroll taxes, the IRS will send out a Federal Deposit Tax Alert Notice to the business.  If unanswered a Revenue Officer (“RO”) is assigned to the business to investigate the reason the business in non-compliant. The RO will attempt to bring the business into compliance by directing the business to set up a special trust account for the deposit of employment taxes. If the business fails to come into compliance, the next step will be to conduct an investigation of potentially responsible individuals against whom the § 6672 penalty can be assessed. The RO will then attempt to secure the business’s bank records and other records of the business. The RO will also issue Letter 3586 to the potentially responsible individuals setting a meeting (“Interview”). Letter 3586 is accompanied by Notice 784 “Could You Be Personally Liable for Certain Unpaid Federal Taxes.”

Following the Interview, the RO will determine whether to proceed with the proposed assessment. If the RO decides to move forward, he or she will generate and send the responsible person a 60 day Preliminary Notice styled as “Letter 1153” together with Form 2751 (“Proposed Assessment of Trust Fund Penalty”)   Thereafter, the IRS must wait 60 days after the issuance of Letter 1153 and the Proposed Assessment before issuing a notice and demand for payment. The responsible party has 60 days to respond and 75 days if the letter is addressed out of the country.

Most individuals are ill equipped to handle an IRS Interview and may unwittingly say something that will be used to establish responsible party status. In some cases, an individual’s statements may serve as a basis for a referral to the Criminal Investigation.  The RO will use Form 4180 (“Report of Interview with Individuals Relative to Trust Fund Recovery Penalty”) when conducting TFRP Interview.

Prosecutors will typically look to see whether an IRS Form 2751 or Form 4180 was completed during the civil administrative part of the case, because these documents may contain relevant admissions or statements by the defendant. See Moore v. United States, 648 F.3d 634, 636 (8th Cir. 2011) (approved admission of Form 2751 in § 6672 case); United States v. Thayer, 201 F.3d 214 (3d Cir. 1999) (in § 7202 case, the court noted that the defendant signed a Form 2751, “accepting personal responsibility for

unpaid tax liability and civil penalties”); United States v. Korn, 2013 WL 2898056 (W.D.N.Y. 2013) (in § 7202 case, Magistrate Judge noted that the Revenue Agent’s interview of the defendant was memorialized on a Form 4180).

Internal Revenue Code Section 7202 is used to prosecute persons who willfully fail to comply with their

Statutory obligations to collect, account for, and pay over taxes imposed on another person. This includes employment tax crimes, which are regularly prosecuted under § 7202, as well as 26 U.S.C. § 7201 (tax evasion), 26 U.S.C. § 7206(1) (false returns), 26 U.S.C. § 7212(a) (obstruction), and 18 U.S.C. § 371 (conspiracy to defraud).

To establish a violation of § 7202, the prosecutor must prove the following elements beyond a reasonable doubt:

(1) Duty to collect, account for, and pay over a tax;

(2) Failure to collect, truthfully account for, or pay over the tax; and

(3) Willfulness.

The element of willfulness under § 7202 is the same as other criminal offenses under Title 26.  In this context, the Government must show that a defendant voluntarily and intentionally violated a known legal duty. Cheek v. United States, 498 U.S. 192, 200 (1991); United States v. Pomponio, 429 U.S. 10, 12 (1976); United States v. Bishop, 412 U.S. 346, 360 (1973). Evil motive or bad purpose is not necessary to establish willfulness under the criminal tax statutes. Pomponio, 429 U.S. at 12.

Thus, Courts have rejected the defense that the trust funds were used tax to pay current expenses so the   company could stay afloat and eventually pay the delinquent tax in the future. Although such facts may have emotional appeal and may have an impact in sentencing, if the government proves the defendant voluntarily and intentionally used unencumbered funds to pay creditors other than the United States, the jury may nevertheless find the defendant guilty even if the intentional non-payment of the known trust fund tax liability was motivated by a desire to keep the business afloat. Cf., Collins v. United States, 848 F.2d 740, 741–42 (6th Cir. 1988) (in a § 6672 case, the court held that “[i]t is no excuse that, as a matter of sound business judgment, the money was paid to suppliers and for wages in order to keep the corporation operating as a going concern—the government cannot be made an unwilling partner in a floundering business Criminal Tax Manual 13-14.

The following represents a sample of 2023 prosecutions evidencing that Employment Tax Fraud is a top priority for the Government:

1. On September 1, 2023 a Kansas woman pleaded guilty to willfully failing to account for and pay over employment taxes to the IRS. According to court documents and statements made in court, Sheryl Clanton owned and operated a Construction Company (“Company # 1”), a business specializing in the construction and maintenance of underground infrastructure. The defendant was President of the Company from 2006 through 2011, responsible for filing quarterly employment tax returns and collecting and paying federal income and Social Security and Medicare taxes withheld from employees’ wages to the IRS. For the first quarter of 2010 through the last quarter of 2011, the defendant did not pay approximately $980,536 in employment taxes owed to the IRS. In 2011, the defendant abandoned the Company #1 due to its outstanding tax obligations and a bank mortgage foreclosure, and started a second Construction Company (“Company #2”). From the second quarter of 2012 through the fourth quarter of 2017, the defendant did not pay approximately $1.1 million in employment taxes or file quarterly payroll tax returns as required by law.  The defendant also operated a third underground construction business (“Company # 3”), organized in late 2011. Between 2012 and 2015, the defendants did not report or       pay nearly $100,000 of employment taxes owed to the IRS on behalf of Company # 3. In    total, the defendant caused a tax loss to the IRS exceeding $2.2 million.

2. On or about August 10, 2023, an Oklahoma man and a Virginia man pleaded guilty, in separate cases, to willfully failing to pay over employment taxes. According to court documents and statements made in court, Stephen Christopher Parker of Oologah, Oklahoma, and Michael Baines of Portsmouth, Virginia, were co-owners of a mental health counseling services company, Family Youth Intervention Services Inc., located in Tulsa, Oklahoma. In that role, the two men were responsible for withholding, accounting for and paying over the income and Social Security and Medicare taxes withheld from the wages paid to the company’s employees. For the second quarter of 2016 they did not file the required quarterly employment tax return or pay over the entirety of those taxes. The two defendants admitted that from January 2014 through December 2017, they did not pay over a total of approximately $1,265,259 in withholdings to the IRS.

3. On July 6, 2023 a Colorado man was sentenced to 15 months in prison for evading the payment of more than $700,000 in employment taxes he owed to the IRS. The defendant co-owned restaurants and an oil production business, which had employees from whose paychecks he withheld income and Social Security and Medicare taxes. Starting in 2002 and continuing for many years, defendant failed to pay over the withheld payroll taxes to the IRS, and further, failed to file the required quarterly employment tax returns for his businesses. After failing to collect from the businesses, the IRS assessed the tax against the defendant personally (26 U.S.C. 6672 “Trust Fund Penalty”).   To prevent the IRS from collecting through bank levies the taxes he owed, the defendant  kept   the balances of his personal and business bank accounts low, often leaving them enough funds to cover expenses and then moved any remaining money to a bank   account not subject to   IRS levy. In total, the defendant  caused a tax loss of   approximately $737,128.

4. On June 22, 2023 a Maryland restaurant owner pleaded guilty to willful failure to account for and pay over employment taxes and to filing a false personal tax return. According to court documents and statements made in court, the defendant owned and operated Maryland restaurant since 1995. As part of managing the restaurant, defendant issued Forms W-2 to his employees and withheld federal income and Social Security and Medicare (FICA) taxes from their wages. However, from 2010 through 2021, the defendant failed to file with the IRS the required Employer’s Quarterly Federal Tax Returns (Forms 941) reporting these employment taxes and did not pay the withholdings over to the IRS. In total, the defendant did not report or pay approximately $2,813,348.94 in employment taxes due and owing to the IRS. Instead of meeting his tax obligations, the defendant used funds from his business to pay other creditors and for a variety of personal expenses, including golf club membership dues, season tickets to the Baltimore Orioles, international vacations, and salaries for himself and his wife.

5. On June 20, 2023 a Minnesota man who owned an automobile transmission business pleaded guilty to willfully failing to account for and pay over employment taxes. According to court documents and statements made in court, the defendant, Timothy J. Lundquist, owned and an automobile transmission remanufacturing company based located in Jordan, Minnesota. The defendant was responsible for filing quarterly employment tax returns and collecting and paying over to the IRS payroll taxes withheld from employees’ wages. For at least the last quarter of 2013 through 2018, the defendant did not pay withholdings to the IRS or file required employment tax returns. In total, he caused a tax loss to the IRS of over $1.2 million.

6. On June 13, 2023 the Chief Financial Officer (CFO) of a Mississippi company pleaded guilty to willfully failing to report and pay over employment taxes withheld from employees’ paychecks. According to court documents and statements made in court, the defendant was the CFO of Construction Company engaged in the business of pipeline-maintenance and construction.  From at least 2012 through October 2018, the defendant, Julian Russ, did not file required quarterly employment tax returns or pay over the taxes withheld from employees’ wages to the IRS, despite knowing of his obligation to do so. In total, the defendant caused a tax loss to the IRS of more than $6 million.  Russ faces a maximum penalty of five years in prison. He also faces a period of supervised release, restitution, and monetary penalties.

7. On June 2, 2023 a Florida man was sentenced to two years and eight months in prison for conspiring to defraud the United States and conspiring to harbor aliens and induce them to remain in the United States. According to court documents and statements made in court, between November 2010 and October 2020, defendant owned and operated several Key West labor staffing companies that facilitated the employment of non-resident aliens in hotels, bars, and restaurants operating in Key West and elsewhere who were not authorized to work in the United States. The Defendant encouraged workers to enter the United States illegally and induced them to remain in the country, in violation of immigration laws. The Defendant’s labor staffing companies paid alien workers without withholding federal income and employment taxes from their wages and did not report said wages to the IRS.

8. On May 24, 2023 a California man was sentenced to 12 months in prison for willfully failing to account for and pay over employment taxes. According to court documents and statements made in court, Larry Kudsk operated two construction businesses in California these companies served as general contractors or subcontractors, including on some government projects. The defendant was responsible for filing quarterly employment tax returns and collecting and paying over to the IRS payroll taxes withheld from employees’ wages for both companies. The defendant did not timely file employment tax returns or pay over withholdings to the IRS, resulting in a tax loss exceeding $250,000.

9. On April 14, 2023 an Iowa man was sentenced to two years in prison for evading payment of employment taxes owed by his company. According to court documents and statements made in court, the defendant, Kevin Alexander, owned a landscaping and construction company. Defendant was responsible for filing quarterly employment tax returns and collecting and paying to the IRS taxes withheld from employees’ wages. Between 2014 and 2017, the Company paid approximately $3.8 million in wages to its employees, of which approximately $1 million in income and Social Security and Medicare taxes was withheld. The defendant did not pay those withholdings over to the IRS. When the IRS attempted to collect unpaid employment taxes, the defendant sought to conceal his income by submitting a form to the IRS concealing the full amount of K&L’s available assets.

10. On March 15, 2023 a Michigan business owner was sentenced to 12 months and one day in prison for failing to collect and pay over to the IRS employment taxes withheld from his employees’ wages. According to court documents and statements made in court, the defendant, Yigal Ziv, owned and operated a software development firm based in Walled Lake, Michigan. The defendant was responsible for filing the Company’s quarterly employment tax returns and collecting and paying to the IRS payroll taxes withheld from employees’ wages. From the first quarter of 2014 through the first quarter of 2018, defendant collected approximately $691,000 in employment taxes from MTI’s employees, but did not file employment tax returns or pay the withheld taxes to the IRS.

11. On March 13, 2023 a federal grand jury in Philadelphia returned an indictment charging a Pennsylvania man and woman with conspiring to defraud the IRS and other tax crimes, including failing to pay employment taxes to the IRS. According to the indictment from approximately October 2013 through December 2021, Theodore Shearba and Jennifer Cemini owned and operated a landscaping and excavation business and attempted to defraud the IRS by (1) not reporting the income they received from the business, (2) using business funds to pay for personal expenditures, (3) not paying employment taxes, including the income tax withheld from employees’ paychecks and Social Security and Medicare taxes and (4) changing business names and concealing business income to thwart IRS efforts to collect the unpaid employment taxes. If convicted, the Defendants each face a maximum penalty of five years in prison for the conspiracy count and each employment tax count.

The above illustration represent a small number of the total prosecutions in 2023, with many industries represented in the mix, including but not limited to construction, technology companies, restaurants, auto dealerships, long term care facilities, and  landscaping companies just to name a few.

If you are involved in a business that is delinquent on its payroll taxes, there is a high likelihood that you will be investigated by the IRS.  Those individuals responsible for management of the business are particularly vulnerable to the TFRP should the business ultimately fail to pay its employment taxes, and may in certain cases be subject to criminal prosecution.

When looking into the issue of responsibility, the IRS will most always pick the low hanging fruit.  Since the IRS considers failure to pay your employment taxes stealing, the necessity of legal representation cannot be understated. If the IRS is currently conducting an investigation into the employment taxes of your business or you are behind in your payroll taxes, it is important to be proactive particularly if there is a risk of a referral to Criminal Investigation of the IRS. As such, a potentially responsible person should never attend an Interview without the assistance and advice of counsel, since any statement you make may be considered an admission of guilt.

Many individuals I have counseled over the years simply waited too long. You cannot hide your head in the sand!