New light cast on implementation of US ‘Trust Fund Penalty’ rules

In the Byrne v United States case, the owners of a US automotive supply company were let off the hook after proving they were unaware that payroll taxes were not being paid.

The trust fund penalty comes into play if a responsible party is deemed to have wilfully failed to deposit payroll taxes on time. It results in them being held liable for 100% of the shortfall. A ‘responsible party’, meanwhile, is considered to be anyone who has a duty to undertake, or the power to direct, the collecting, accounting and payment of trust fund taxes, which includes company owners who are not necessarily involved in day-to-day operations.

In the Byrne v United States case, Eagle Trim’s president Roger Byrne and chief executive Eric Kus were both able to hire and fire staff and had signature authority over the firm’s bank accounts. The filing and payment of employee trust fund taxes was handled by a controller, while year-end audits and the preparation of income tax returns was dealt with by a third party accountancy firm.

Based on recommendations from the accountancy firm, Eagle Trim hired both an accountant and chief financial office to look after day-to-day issues. But due to financial irregularities, which included the controller overstating the company’s receivables, it failed to pay its payroll taxes on time and eventually had to declare bankruptcy.

The accountancy firm had informed Byrne and Kus that there were some problems but, according to accountingWeb, effectively gave the organisation a clean bill of health on its financial statements. This “clean audit” was later revoked when the accountancy firm learned of the controller’s fraud.

The Internal Revenue Service (IRS) assessed, therefore, whether the two owners were liable under the trust fund penalty. But when a district court ruled they were involved in a “wilful failure” to pay the payroll taxes, they appealed to the 6th Circuit Court.

The IRS definition of what constitutes “wilful failure” is broad. This means that failing to pay the tax owed does not have to be intentional but can be based on whether an individual knew, or should have known, that they were unpaid.

The 6th Circuit Court subsequently overturned the district court’s ruling, saying that the owners had taken reasonable steps to ensure the taxes were paid in a timely fashion and that they reasonably believed they were being paid. In other words, because they did not have actual knowledge that the trust fund taxes were not being paid until after the assessment took place, it meant they did not wilfully fail to pay.