Listen to this post

It’s Still Pretty Bad

Depending upon what you read or, perhaps more accurately, depending upon how much you believe of what you read, you may be aware that many closely held businesses are concerned about their future.

Most of these survived the disruption caused by the pandemic lockdown only to be confronted with rising inflation, higher borrowing costs, a scarcity of available workers, the phaseout of COVID-era public support programs, and the potential for increased federal and state tax burdens.

Add to these already daunting challenges the prospect of a destabilized society and an ever more threatening world, and you can understand why many owners may be fearful for the future of their business.

Staying Alive

Owners will generally do what they can to keep their businesses viable. Although the great majority of owners will remain within the boundaries of the law, a not insignificant number may consider, and ultimately follow through with, a “strategy” that is often utilized by businesses in distress.

Specifically, such a business may intentionally fail to remit to the taxing authorities those taxes that the business has withheld or collected on their behalf – typically, an employee’s share of employment taxes on wages paid by the employer-business, as well as state and local sales taxes.

Why would a business engage in such behavior? The reasoning goes something like this: “Revenues were down. We just needed some time to recover – the tax dollars withheld were going to pay expenses and help us sustain the business until it became profitable once again. At that point, we would have paid the back taxes owing.” 

As you can imagine, it rarely works out that way, the business fails, and the owners are left holding the proverbial bag.

Bad Actors

There are times, however, in which this decision is not consciously adopted as a matter of “company policy” but, rather, is undertaken by only one well-positioned owner or officer of the business, unbeknownst to the others.

At other times, an outside service provider may divert the taxes withheld, not to benefit the business, but for their own personal gain; in other words, they embezzle the money.

A recent decision of the U.S. Tax Court[i] considered a case of embezzlement by the accountant for a closely held business that resulted in the business failing to satisfy its obligation to remit to the IRS the taxes withheld from its employees’ wages.

I suppose the case is mildly entertaining in a morbid sort of way, but before describing the circumstances presented to the Court, let’s briefly review the applicable law.

Trust Fund Recovery Penalty 
Federal law requires employers to withhold income, Social Security and Medicare tax from their employees’ wages at the time that the wages are paid to the employees.[ii] The withheld taxes are held in trust by the employer, to be remitted to the IRS at the appropriate intervals.[iii]

Because the withheld taxes are held in trust by the employer, the funds may not be used for any other purpose. If these taxes are not timely remitted to the government, the latter can pursue the company’s officers individually for the unpaid taxes, plus penalties and interest – the so-called Trust Fund Recovery Penalty (TFRP).[iv]

The Code provides:

Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.

A “person” within the meaning of this provision includes an officer or employee of a corporation who is under a duty to perform the act with respect to the alleged violation.[v]

To incur liability for the withheld taxes under this provision, an individual must be a responsible person – one who is under a duty to act – and must willfully fail to pay over the taxes in question. Stated differently, “[a] responsible person is someone who has the status, duty and authority to avoid the corporation’s default in collection or payment of the taxes.” 

Because “responsibility” for purposes of this rule is based upon one’s status, duty and authority within the employer organization, it is possible that more than one person may be identified as a “responsible.” However, that fact alone is immaterial to determining another responsible person’s liability.

In addition, a “responsible person” will not be relieved of their status – or absolved from their failure to collect and/or pay over a tax – merely because of the malfeasance of a subordinate.

With these basics in mind, let’s turn to the Court’s decision.

Mathematically Challenged

Taxpayer organized and incorporated Company as a management consulting and executive recruiting business.

Taxpayer was Company’s chief executive officer (CEO) and its sole shareholder. He had the authority to hire and fire employees of Company and exercise control over Company’s bank accounts.

Taxpayer claimed to suffer from a learning disability with respect to mathematics,[vi] though he was otherwise competent to conduct his personal and business affairs. Throughout his professional career, Taxpayer delegated many business, and sometimes personal, financial responsibilities to various employees and accountants, including to a particular certified public accountant (CPA).

Before the periods in dispute, Taxpayer hired CPA to manage Company’s bookkeeping and other accounting matters. Unfortunately for Company and Taxpayer, CPA embezzled between one and two million dollars from Company over an unspecified period of years.  

You Can’t Make It Up

The embezzlement scheme was discovered under very unusual circumstances.

CPA was meeting with Taxpayer and Taxpayer ‘s financial planner to go over financial records that, unbeknownst to the others, CPA had fabricated to cover up his embezzlement.

It may have been guilt or regret, or it may have been karma. Whatever the cause, CPA suffered a heart attack.[vii]

Query whether Taxpayer would have acted differently had he been aware of the losses Company incurred on account of CPA’s betrayal. In any case, Taxpayer immediately “took actions” that, according to him, saved CPA’s life.

Following this close encounter with his own demise, and while recovering at the hospital, CPA confessed to the embezzlement.[viii]

Taxpayer hired attorneys and accountants to reconstruct the amount of the losses that Taxpayer and Company sustained because of CPA’s embezzlement. Later, Taxpayer and Company sued CPA and others to recover those losses.

According to the complaint filed in one of those lawsuits, CPA embezzled and spent funds that were allocated for the payment of Company’s employment taxes.

Company and Taxpayer subsequently sued the bank that CPA used to further his embezzlement scheme.

While Taxpayer’s lawsuits were pending, Taxpayer continued to operate Company, during which time he paid himself a bonus.

Also during this time, math-challenged Taxpayer transferred funds from Company’s bank accounts to accounts maintained by a new business entity that Taxpayer had organized.

The lawsuits were eventually settled by the payment of substantial sums to Taxpayer.

Taxpayer used a portion of these settlement proceeds to pay personal expenses. None of the settlement proceeds from either lawsuit were used to pay any of Company’s outstanding employment tax liabilities.[ix]

The IRS Steps In

The IRS determined that Company had failed to collect and/or remit certain employment taxes owed for certain periods. After appropriate supervisory approval for the assessment of the TFRP, the IRS notified Taxpayer of the then-proposed TFRP assessment.

Taxpayer and his representatives subsequently met with an IRS revenue officer to discuss whether Taxpayer should be held liable for the TFRP.

The IRS assessed the TFRP and notified Taxpayer that a Notice of Federal Tax Lien (NFTL) had been filed with respect to the underlying liability. Taxpayer was advised of his right to request an administrative hearing to challenge that collection action, which he did.

On the form requesting a hearing, Taxpayer checked the box for “Offer in Compromise” and took the position that there was doubt as to the underlying liability. Taxpayer was later notified of the IRS’s determination to proceed with collection of the underlying liability.

In response to that determination, Taxpayer filed a Petition with the Tax Court challenging the IRS’s determination of the existence of that liability.[x] 

The Court’s Analysis

The issue before the Court was whether Taxpayer, as the sole shareholder and as an officer of Company at the relevant times, was a person required to collect, truthfully account for, and pay over the employment taxes in question. 

According to the IRS, when the Company failed to withhold and/or pay over certain employment taxes to the IRS, Taxpayer became liable as a responsible person for the Trust Fund Penalty in an amount equal to those employment taxes.

Of course, Taxpayer argued he was not a responsible person at the relevant times.

The Court explained that, under the Code,[xi] “[a]ny person required to collect, truthfully account for, and pay over” any federal tax “who willfully fails” to do so, shall “be liable to a penalty equal to the total amount” of that tax. The Court added that the word “person” as used above, included an officer or employee of a corporation who is under a duty to collect, account for, and pay over the tax.[xii] The Court stated that such persons are referred to as “responsible” persons. It then observed that the term is “broadly applied.”

The Court then expanded upon the foregoing definition, stating that whether someone is a responsible person is “a matter of status, duty and authority, not knowledge.” The essential question, the Court added, is whether the person had sufficient control over an employer-taxpayer’s affairs to ensure the payment of the taxpayer’s employment taxes.

According to the Court, the indicia of that control held by a responsible person include “the holding of corporate office, control over financial affairs, the authority to disburse corporate funds, stock ownership, and the ability to hire and fire employees.” In considering an individual’s status, duty, and authority, the Court continued, “the test is one of substance, and the focus of the inquiry does not involve a mechanical application of any particular list of factors.” In other words, the inquiry must focus on actual authority to control, not on “trivial duties.”

According to Taxpayer, because of his allegedly limited ability to comprehend mathematical concepts, he was not a responsible person.

According to the IRS, because of Taxpayer’s position, authority, and control over Company’s affairs, he was responsible for ensuring that Company’s withholding tax obligations were satisfied.

The Court agreed with the IRS.

Court’s Opinion

During the relevant periods, Taxpayer was Company’s CEO and sole shareholder. Taxpayer controlled the financial affairs of Company, disbursing corporate funds both to himself and to a newly formed business entity. Taxpayer also exercised authority to hire and fire employees and delegated various tasks involved in operating Company to those employees. Taxpayer apparently made the decision to sue CPA on Company’s behalf.

Therefore, the Court concluded, Taxpayer clearly had and exercised control over Company’s corporate affairs.

Responsible Person

Still, Taxpayer pointed to his difficulties comprehending mathematical concepts and noted that he hired others, including CPA, to take responsibility for Company’s bookkeeping and tax matters. As Taxpayer viewed the matter, the failure to pay Company’s employment taxes resulted from CPA’s embezzlement, not from anything Taxpayer did or failed to do.

Relying heavily on these reasons, Taxpayer argued that he should not be held liable as a “responsible person” for Company’s employment taxes.

In response to these assertions, the Court focused on Taxpayer’s authority to control Company’s obligations to pay its employment taxes, not on whether he personally took responsibility for that duty. Considering Taxpayer’s position with Company and taking into account his decisions to disburse Company funds to pay for items other than Company’s employment tax liabilities, the Court found that Taxpayer was a responsible person for purposes of Company’s outstanding employment tax liabilities.


Taxpayer also challenged the assessment of the TFRP because he did not “willfully” fail to pay Company’s employment taxes for the period or periods here in dispute.

The Court explained that once a person is demonstrated to be a “responsible person,” the burden is on that person to establish that the failure to pay a tax was not willful. 

“Willfulness” for this purpose, the Court continued, was indicated if a responsible person, instead of paying a taxpayer’s outstanding employment taxes, used the taxpayer’s funds for other purposes.

In the present case, Taxpayer became aware of Company’s – as well as his own – failure to pay employment taxes no later than when he filed a lawsuit alleging that CPA had “confessed to spending the funds allocated for payment of employment taxes.” Yet, after learning of the failure to pay Company’s employment taxes, Taxpayer nonetheless disbursed Company’s funds to pay obligations other than those owed to the IRS: Taxpayer transferred funds from Company to a newly formed business entity that he organized after Company’s employment taxes were assessed; he paid himself a not insignificant bonus; and he used the proceeds received from the settlement of the lawsuits for various other purposes, but not to satisfy any of Company’s outstanding employment tax liabilities.

Taxpayer blamed the failure to pay Company’s employment taxes on CPA, but the Court refused to accept that Taxpayer’s delegation of the responsibility to collect and pay over Company’s employment taxes could support a finding that Taxpayer did not willfully fail to pay those employment taxes. Taxpayer was obligated to ensure that Company’s employment taxes were collected and paid over to the IRS even though he delegated responsibility for discharging that duty to CPA. 

The Court found that Taxpayer failed to demonstrate that his failure to satisfy Company’s employment tax liabilities was not willful.

Reasonable Cause

Likewise, the Court rejected Taxpayer’s suggestion that he had reasonable cause for failing to ensure that Company’s employment tax liabilities were satisfied. The Court pointed out that, after becoming aware of Company’s outstanding employment taxes, Taxpayer used Company funds for other purposes. “No such defense may be asserted,” the Court stated, by a responsible person who knew that the withholding taxes were due, but who made a conscious decision to use corporate funds to pay creditors other than the government.” 

Importantly, the Court added, like employers who handle their own payroll duties, employers who outsource this function still are legally responsible for any and all payroll taxes due; i.e., federal income taxes withheld, as well as both the employer and employee’s share of Social Security and Medicare taxes. This remains true even if the responsible person outsourced the payroll tasks and forwarded all of the funds to a third-party provider to make the required deposits or payments.

Parting Thoughts

It isn’t easy running a business. One has to deal with often difficult customers or clients, sometimes unreliable vendors or suppliers, always determined competitors, demanding creditors, a mixed bag of employees, and at times uncooperative partners.[xiii] During their free time, the owner focuses on the core of their business, and the reason they went into business in the first place – the services they provide or the product they manufacture.

Under these circumstances, it is necessary that various administrative duties be delegated to others.

That said, it is imperative that the owner familiarize themselves with the tax obligations imposed upon their business, that they periodically check in with (and upon) those to whom they have assigned the task of satisfying these obligations, and that they immediately address any apparent errors or inconsistencies, as well as any suspicions. 

Sign up to receive my blog at
The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.

[i] Taylor v. Comm’r, T.C. Memo. 2024-33.

[ii] IRC Sec. 3101, 3102(a), (b), 3402, 3403. In some cases, sooner; for example, nonqualified deferred compensation may be included in income for certain withholding tax purposes when the employee becomes vested in the benefit, even though payment may not occur until a later year.

[iii] IRC Sec. 7501.

[iv] IRC Sec. 6672(a).

[v] IRC Sec. 6671(b). 

[vi] The Court didn’t elaborate on this and, frankly, my initial response was to doubt Taxpayer’s veracity. However, it turns out there are various learning disabilities that involve one’s ability to do math; for example, dyscalculia.

[vii] It’s also possible that CPA was on a Big Mac Large Fries Chocolate Shake diet. No, this isn’t about me. I prefer vanilla.

[viii] A “nearly deathbed” confession.

[ix] You know where this is going.

[x] A taxpayer who challenges an underlying liability in cases such as this one bears the burden of proof regarding the correct tax liability. TC Rule 142(a).

[xi] IRC Sec. 6672(a)

[xii] IRC Sec. 6672(a) and Sec. 6671(b).

[xiii] It’s a wonder that as many folks go into business for themselves as they do.