Actions May Be Needed to Eliminate or Minimize Personal Liability for Corporate Payroll Tax Delinquencies During COVID-19
The virus-induced shutdown has left many small businesses cash-strapped and facing an uncertain future. With the reopening of the economy and many businesses operating at 25%-50% capacity, small business owners will have to make some difficult decisions, at least initially, as to (i) how best to conserve cash, (ii) which vendors/bills to pay now and (iii) which monthly overhead expenses to forego for now, allow to become delinquent, and pay later. It is expected that many companies will choose to forego their regular payroll deposits during this difficult time and use these funds withheld from employees’ paychecks as a “bridge” loan/source of cash until normal operations resume later this year or in 2021. This would be a bad move on a number of levels but could be disastrous for owners, officers, and possibly employees of a business taking this approach to COVID-19 cash management as it exposes these individuals to potential personal liability for the business’s delinquent payroll taxes.
The main reason most businesses today conduct operations through a corporation, LLC or some other business entity is to insulate the owners of the business from personal liability for the company’s debts and obligations. For, the general rule is that shareholders/members are not personally liable for the entity’s debts, liabilities, or other obligations. However, there is one exception to this basic corporate law principle – payroll taxes. Under federal tax law, certain individuals can be held personally liable for the payroll taxes that are withheld from an employee’s paycheck (known as the trust fund portion of the payroll taxes) but not paid over to the government as required. When the IRS is unable to collect delinquent payroll taxes from the business entity itself, it will usually assess the trust fund portion of the delinquent payroll taxes (just the taxes withheld from employees’ paychecks) against those individuals the IRS deems to be “willful” and “responsible”. This assessment is known as the Trust Fund Recovery Penalty (“TFRP”).
Although there are a number of factors/criteria used by the IRS in determining those individuals who are “willful” and “responsible” and, thus, liable for the TFRP, the IRS usually starts with the owners and officers of the entity. The IRS obtains this information from state business filing records (via Sunbiz for entities formed in Florida). Next, the IRS will request from the bank via summons the entity’s canceled checks and signature cards for its business bank account(s) and assess the TFRP against all individuals who have signed, or are authorized to sign, checks on behalf of the entity. Finally, the IRS will attempt to identify other “willful and responsible” parties by conducting interviews with those individuals it has already identified through the methods outlined above. The IRS can collect the trust fund taxes only once (but can collect all of the tax from one individual) but typically “casts a wide net” so as to maximize prospects for locating someone with “deep pockets” and collecting 100% of the delinquent trust fund taxes.
So, what can you do at this point to eliminate or minimize your exposure to the TFRP in case the entity you are involved with chooses to “borrow” the trust fund taxes it withholds from employees’ paychecks and use these funds for working capital during the Pandemic? If you are the President or CEO or otherwise the day-to-day decision-maker for the entity there is not much you can do to minimize your exposure to the TFRP. However, if you are a passive investor/owner or otherwise not involved in the day-to-day business operations of the entity (especially payroll and accounts payable) you should strongly consider taking the following actions as soon as possible: (i) remove yourself as an authorized signatory on each of the entity’s bank accounts, (ii) resign from any officer and/or director positions with the entity and (iii) forward an e-mail or other written communication to the President of the entity reminding him/her of the need to remain current with payroll tax obligations at all times and ask for written confirmation that you have no role or involvement in the payroll process or the day-to-day business decisions as to which expenses will be paid and when.
By taking these steps you give yourself a good chance of avoiding a TFRP assessment in the event the entity falls behind on its payroll taxes, at least with respect to payroll tax liabilities going forward. You also give yourself a fighting chance to successfully appeal any future TFRP assessments against you. After all, no matter how ill-advised it is to pay non-payroll overhead at the expense of payroll tax deposits, you have to expect this to occur during the remainder of this year and possibly into 2021 as we work ourselves through this historic Pandemic.