The U.S. Fourth Circuit Court of Appeals, which covers Maryland, recently rendered a tax decision noteworthy to all married couples who participate in their business together. The case, Johnson v. U.S., decided November 5, 2013, is significant because a wife, who participated in a company with her husband on a limited basis, was held liable for unpaid payroll taxes in spite of the fact that she had only limited involvement with the operation of the company and did not learn of the failure to pay the payroll taxes until she was notified by the IRS.
Internal Revenue Code Sec. 6672 imposes what is known as the Trust Fund Recovery Penalty on any person who: (1) is responsible for collecting, accounting for, and paying over payroll taxes; and (2) willfully fails to perform that responsibility. This penalty imposes personal liability for failure to pay certain employment taxes. The wife in this case argued that she did not act willfully in failing to pay the tax, but her argument was rejected due to the fact that she paid other creditors after receiving a notice from the IRS. In analyzing the issue of willfulness, courts focus on whether the person being charged with the penalty had “actual knowledge” of the failure to pay or acted with “reckless disregard” toward the lack of payment.
In Johnson, the husband closed a not-for-profit business which he operated due to a lien for unpaid payroll taxes filed by the IRS against him as its owner. He then approached his wife to engage in a restructuring of the company. As a result, the non-profit was converted to a “for profit” with the wife as the sole stockholder, which allowed it to conduct business unfettered by the lien against Mr. Johnson, to which his wife was not subject.
Mrs. Johnson was caring for the couple’s children while her husband “ran the business”. However, in her capacity as sole stockholder she conducted the formalities of the corporation as sole stockholder and a corporate officer. Each of she and her husband had authority over the business’ bank accounts. Although her participation and authority was limited, she received a salary and other corporate “perks”.
Mrs. Johnson received a notice from IRS that the corporation had not paid its payroll taxes for several quarters from 2001 through 2004, a fact of which she was unaware before receiving the notice. At that point, she took measures to see to it that payroll taxes were timely paid, but she did nothing to ameliorate the issue of the “past due” payments to the IRS. She continued to pay creditors of the business, including wages and her own compensation. As a result, the IRS assessed “The Trust Fund Recovery Penalty” penalties against each of Mrs. Johnson and her husband.
Mrs. Johnson made a payment of $351 toward the assessed penalty and subsequently filed suit in the U.S. District Court seeking a refund of the amount she paid as erroneous. The IRS counterclaimed for penalties, interest and costs in an amount exceeding $304,000 from Mrs. Johnson and exceeding $240,000 from her husband.
The couple lost all their arguments. The District Court granted summary judgment to the government, finding that Mrs. Johnson had acted “willfully” as required by the statute, a point which she had contested.
On appeal the Court of Appeals looked to the following facts in deciding that Mrs. Johnson was a “responsible person” (Mr. Johnson failed to advance any significant argument against his status as a responsible person):
Her signature authority gave her “effective power” to pay the taxes e.g. the ability to do so.
She could change officers and directors as sole stockholder; and, therefore, she had “actual” authority to act.
Entrusting her “authority” to her husband did not relieve her of the authority to act.
Finally, it made no difference that she learned of the past due payroll taxes until IRS issued its notice of deficiency. Once she learned of the past due amounts, it was her responsibility to use all available funds of the business to pay those taxes. It is improper for a responsible person to pay other debts while ignoring the payroll tax deficiency.
The lesson to be learned from the Johnson case is that love does not conquer all, and that spouses, even those who are trusting and happily married, must familiarize themselves with businesses in which they are asked to participate. It is not enough to hear those all too familiar words: “Don’t you trust me?”; “You won’t understand!” Make a wise choice and seek counsel from your PK Law attorney before signing on as a “responsible person”. There could be economic consequences if you are not careful.