Employees are required to withhold federal income and social security taxes from the wages of their employees. If an employer fails to do so, the government will often assert the trust fund recovery penalty (“TFRP”) against those responsible for payroll decisions.
Generally, the bar to assert the TFRP is a low one. First, the government must merely show that the taxpayer was a “responsible person,” i.e., someone with a certain degree of decision-making authority over payroll. Although this almost always includes owners of the employer company, it also commonly ensnares others such as executives or directors of the company. Second, the government must show that the responsible person acted “willfully.” For these purposes, willful conduct generally means that the responsible person voluntarily chose to pay other creditors over the IRS with knowledge of the outstanding IRS payroll obligations.
Because the responsible person definition is so broad, many taxpayers are left to argue that they should not be liable for the TFRP under the willfulness requirement. The recent decision of Preimesberger v. United States, No. 1:19-CV 1441 AWI SAB, 2020 WL 4504421 (E.D. Cal. Aug. 5, 2020) is a good illustration of case where a taxpayer was successful in arguing he was not willful, and is the topic of this article.
Facts of Preimesberger.
Mr. Preimesberger was a minority shareholder of a holding company, Meridian Health Services Holdings, Inc. (“Meridian”). Meridian owned five separate nursing home facilities in California.
As is common with nursing homes, Meridian depended largely on federal and state reimbursements for its nursing home care, including Medicare and Medi-Cal. However, from 2010 through 2015, Medicare and Medi-Cal began to delay reimbursement payments to Meridian, resulting in financial difficulties for the company.
To ease these difficulties, Meridian obtained a line of credit from Capital Finance, Inc. (“CFI”). Although the line of credit assisted Meridian with its operations, CFI would not permit Meridian to use the loan proceeds for employment taxes. Accordingly, Meridian fell behind on its payroll tax obligations to the IRS.
Interestingly, Meridian, as a nursing home company, could not simply cease its operations. Rather, federal and state law and regulations required the company to go through a lengthy winding up process to ensure that medical care to the nursing home residents was not disrupted. A failure to follow these procedures could result in significant civil and criminal penalties to Meridian and its owners.
Because Meridian fell behind on its payroll tax obligations, the IRS assessed TFRPs against Mr. Preimesberger. After the assessment, Mr. Preimesberger paid a portion of the employment taxes at issue and filed a claim for refund. The claim for refund was denied, and Mr. Preimesberger filed a lawsuit against the government in the Eastern District of California.
After the lawsuit was filed, the government moved to dismiss Mr. Preimesberger’s complaint. Because Mr. Preimesberger did not dispute that he was a responsible person, the parties’ arguments primarily focused on whether he was willful in not remitting payroll taxes to the IRS.
The government contended that Mr. Preimesberger was willful because he voluntarily made payments to utility companies, employees, and landlords when the IRS was owed payroll taxes. And although the government conceded that the nursing home was required to continue its operations under federal and state law, the government contended that a responsible person was nevertheless willful under these instances when other creditors were paid over the IRS.
Conversely, Mr. Preimesberger argued that he could not be willful. Specifically, he contended that because he was required by federal and state law to pay other creditors to continue the nursing homes’ operations, his conduct was not voluntary.
The Court’s Decision.
Based on the factual allegations in the complaint, the court found in favor of Mr. Preimesberger. In finding that Mr. Preimesberger was not willful, the court stated:
In essence, the Complaint alleges that Preimesberger could not simply cease operations when the cashflow situation reached its pinnacle. Instead, federal and state regulations required Preimesberger to keep the Facilities operating at the existing standard of care. To accomplish this, Preimesberger had to utilize a line of credit from CFI. The line of credit permitted the Facilities to maintain the standard of care by paying employees, utilities (which powered necessary medical and therapeutic equipment), and landlords. Although Preimesberger attempted to obtain funds from CFI that would cover the withholding taxes, CFI refused to release funds for that purpose. Given the allegations regarding the Facilities’ dire cashflow situation and the allegations that Preimesberger attempted to meet the various competing legal obligations (pay trust fund taxes and maintain the standard of care), the Court will infer Preimesberger had no other viable funding options other than CFI’s line of credit. That is, the only way that Preimesberger could meet his mandatory regulatory obligations, which carried with them civil and criminal penalties for their violation, was to follow the restrictions of CFI. Additionally, the allegations indicate that the money that was received from CFI was used to pay expenses/creditors that were necessary to maintaining the existing standard of care. There are no allegations that the Facilities used CFI’s funds to pay expenses that were not necessary to maintaining the standard of care. Apart from the restrictions imposed by CFI, federal and state regulations appear to have de facto required that CFI’s loan be spent to maintain the standard of care, which could arguably make the funds expended ‘encumbered.’ Cf. Nakano, 742 F.3d at 1211. Under these circumstances, Preimesberger’s actions may be considered involuntary and thus, not willful.
The Preimesberger decision serves as another reminder that the government must prove not only that a person is a responsible person but also willfulness to successfully assert and impose TFRPs. Taxpayers with potential TFRP issues would be wise to consult with legal counsel to ensure that all non-willful arguments are properly raised.