By Dallas G. Thomsen, LL.M.
Published in the Sussman Shank Spring 2009 Newsletter
Most employers operate as a corporation or limited liability company ("LLC"). Using such an entity generally limits owners' individual liability for the employer's obligations. Except in special circumstances, creditors of a company can look only to the assets of the company to satisfy the company's obligations and not to the owners' personal assets.
Many owners do not realize, however, that the limited liability provided by a corporation or LLC will not keep owners from being personally liability for certain withheld taxes that are to be held in withholding trust accounts. In fact, liability for employee withholdings may be imposed not only on the employer, but on a broad range of people involved in the employer's business.
How does the problem start?
It is tempting for an employer to "borrow" money from withholding trust accounts in order to meet more immediate debts and obligations. In our current economy, the money in the employer's trust account may be its only liquid assets. When the business fails to turn around and the employer is unable to replace the funds, the employer (and other responsible persons) can be held personally liable for payment of the withholding taxes.
Personal liability for trust fund taxes may be imposed on "responsible persons" that willfully fail to pay the trust fund taxes.
Trust fund liability taxes
The most common taxes subject to trust fund liability are taxes withheld from employees. Income tax, social security and Medicare taxes are withheld from the employee's paycheck. The Internal Revenue Service ("IRS") and state agencies view these funds as the employee's money (not the employer's) that the employer holds "in trust" on behalf of the employee for payment to the IRS and state agencies. The employee receives credit for paying these taxes even if the employer does not pay the withheld funds over to the IRS or state agencies.
In addition, certain sales taxes may also be considered trust fund taxes. For example, the State of Washington has implemented statutes imposing personal liability on certain persons for not paying sales tax to the State, similar to employee withholdings.
Personal liability for trust fund taxes is imposed on the employee portion and does NOT include the employer portion of the withheld taxes. In addition, no personal liaibility is imposed for the late deposit penalties, the late payment penalties or the interest thereon.
Personal liability for the trust fund taxes may be imposed on responsible persons. "Responsible persons" are those who are in charge of and have the authority to decide which creditors to pay (including the IRS or state agency). These people may include those who sign tax returns (or other related IRS or state filings), sign or have the authority to sign checks, and those who make financial decisions. Typically, responsible persons include directors, officers, LLC members, LLC managers, bookkeepers and individuals named on the employer's bank account signature card.
"Responsible persons" do not include people with no actual authority. For example, a bookkeeper who is authorized to prepare and sign checks, but does not have the actual authority to send the checks without prior approval may not be a responsible person for trust fund liability purposes.
Willful failure to pay trust fund taxes
In order to be liable for the trust fund taxes, the responsible person must also willfully fail to pay. Generally, this requires the responsible person to: (1) know that the taxes are due and owing and (2) choose to pay other creditors instead of the IRS or state agency.
In addition to the personal liability, other negative consequences may arise when trust fund taxes are not timely paid:
• Sales and employment tax liability is not discharged by bankruptcy.
• Even if the funds withheld are paid, the IRS may charge interest and a penalty of up to 20 % for late deposits.
• Liability can be imposed on successors of the business under certain circumstances. Prospective buyers should investigate thoroughly.
Trust fund liability is a serious issue. While the withholding trust accounts may appear to be an accessible source of cash for hurting businesses, there are significant consequences for not paying the trust fund taxes (or making late payments). If the employer's business must close, most debt may be discharged on dissolution of the entity that operates the business. However, dissolving the entity will not protect the owners (and responsible persons) from personal liability for trust fund taxes. Instead of taking "loans" from trust funds to meet current debts, a responsible business should seek out other alternatives.
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