Businesses, including sole proprietorships, partnerships and corporations, routinely have fiduciary tax responsibilities to the Internal Revenue Service and state taxing authorities to collect, report and remit certain taxes. These taxes are often referred to as “trust fund” taxes, namely, employee wage withholding, including FICA taxes (social security and Medicare withholding) and sales taxes.

The problem that arises is when a business fails to remit trust fund taxes and either the Internal Revenue Service, New Jersey Division of Taxation or another state taxing authority goes after responsible individuals personally for the non-payment of these taxes. When a business withholds employment taxes from employee wages or receives payments of sales tax from customers, the business is in possession of funds that it is obligated to remit to either the federal or state government. The business is effectively holding government property. To guard against businesses failing to remit such “trust fund” monies, harsh penalties are imposed on responsible individuals.

The Internal Revenue Code imposes a penalty equal to the amount of unpaid taxes on any person required to pay federal taxes who willfully fails to do so. Generally, this would include corporate officers, general partners and limited liability company (LLC) members. Sometimes accounting personnel, such as bookkeepers, have been found liable due to extensive decision-making authority. There have been countless court cases litigated over this subject. There must be a finding of personal fault that exceeds mere negligence. The willfulness element is established only if the responsible person either: (1) deliberately or recklessly disregarded facts and known risks that the taxes were not being paid, or (2) had knowledge of the tax delinquency and knowingly failed to rectify it when there were available funds to pay the government. Corporate officers have been known to argue that they were merely investors and detached from day-to-day operations, and therefore should not be liable for said penalties.

New Jersey imposes a similar penalty on responsible persons where either gross income tax withholding or sales tax is not remitted by the business that collected the taxes. The state has a landmark case, Cooperstein v. New Jersey Division of Taxation, decided in 1993 – long before LLCs came into existence. The state cited all of the following as factors to be considered in determining whether the individual had a duty to act on behalf of the business:

• Contents of corporate bylaws;
• One’s status as officer and/or stockholder;
• Authority to sign checks and actual exercise of this authority;
• Authority to hire and fire employees and actual exercise of this authority;
• Responsibility to prepare and/or sign tax returns;
• Day-to-day involvement in business or responsibility for management;
• Power to control payment of corporate creditors and taxes;
• Knowledge of failure to remit taxes when due; and
• Derivation of substantial income or benefits from corporation.

While recognizing that a temptation can exist to delay remitting employee wage withholding and/or sales tax funds when a business experiences cash flow difficulties, this is usually not a good idea and can lead to significant personal liability for the officers and owners. Years ago, you may have signed an IRS Form SS-4 to obtain an employer identification number or a NJ REG-1 form to register your business with New Jersey, identifying yourself as a business officer. The Internal Revenue Service as well as New Jersey Division of Taxation may have that information on record and could use it against you in a trust fund recovery penalty situation.

Neil Becourtney, CPA
CohnReznick LLP