Episode 433: Navigating Personal Liability: The Impact of Unpaid Employment Trust

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Most employers understand that the US government expects them to collect employment and excise taxes from their employees’ pay, and that this withholding is to be paid over to the IRS. It can be tempting to use this money towards other business expenses, but employers should resist the impulse. Not all employers realize the impact of unpaid employment trust and how that relates to personal liability. The fact of the matter is if the employment trust isn’t paid, managers can be held personally liable to the IRS.

How Unpaid Employment Trusts Can Affect Personal Liability

The impact of unpaid employment trusts can be enormous for individuals. Despite the expectation that a business filing bankruptcy will extinguish all debts, including to the IRS, this is not the case. And even if the business itself has gone bankrupt and cannot pay employment trust liability, the IRS will find someone to hold personally liable for that debt. Much of this standard was set by the case of Begier vs the IRS from 1990. While it is a bit of an older case, it still sets the precedent and is very much applicable today.

However, before we break the case down, it is important to establish a couple of talking points first:

1. Trust fund taxes are essentially employment withholding taxes due to the Internal Revenue Service.
2. Employers pay their employees but hold some money out of those payments to pay the government taxes such as FICA, Social Security, and Medicare. This is called an employment trust. (Contrary to popular believe, a trust is not just something established by a person in the event of their death or incapacitation.) At its root, the definition of trust means having someone hold onto something for the benefit of another.

Now, back to Begier vs the IRS. In this situation, American International Airlines fell behind in paying its employment trust fund taxes, which the Internal Revenue Service was aware of. It was not a small sum by any standard. The airline eventually filed for Chapter 11 bankruptcy. For the first 90 days of the bankruptcy, they acted as a debtor in possession and, during that time, decided to reconcile the trust fund money they owed to the IRS. After 90 days, the court appointed a trustee to come in and take over for existing management.

When the appointed trustee found out about the large sum of money the airline had paid to the Internal Revenue Service when there were many debts still owed to other airline creditors, the trustee sued the IRS to attempt to recover the money. The argument the trustee made was that the IRS was no more superior to other creditors and thus should not get priority over available funds.

The court in Begier held that the money held in trust was never the airline’s money to begin with. So when they went into bankruptcy, those employment trust funds were not part of the “debtor’s estate.” The trustee was not able to recover those funds

But the bigger question is why the airline managers decided to pay off employment trust taxes rather than pay off some of the other airline creditors, especially knowing that some of the other debts were just as large, if not larger, than the IRS debt. While the intentions of the managers cannot be known exactly, it is very likely that they understood that if that particular debt was not paid before the company had no money left, that debt would not be extinguished in the bankruptcy and the human individuals responsible for running the business would be held personally liable for those debts for years to come.

This is important, so we will repeat it again: business managers who are signatories on the company bank account and the people responsible for signing the checks to the IRS, known as “responsible parties” , may be held personally liabile for employment trust and excise taxes if is the business does not pay this money over to the IRS. It may not happen immediately, but if substantial sums of money are due for employment or excise taxes, individuals will eventually receive notices from the IRS that their liability is under examination and they may be personally, and singularly, responsible for potentially millions of dollars owed to the IRS. That is precisely why the airline chose to take the remaining chunk of money they had and paid it to the IRS rather than other creditors.

One would expect that that if a business files bankruptcy, that much of the business’ debt can be forgiven. Employers take note: trust fund liability on the employer’s part does not go away. It is not a dischargeable debt. While federal income tax liability has a statute of limitation and may eventually be discharged, trust fund taxes cannot. A former employer can be retired and living off social security, the business long since dissolved, and the IRS will still expect payments to be made towards employment trust taxes that were never paid.

 

When a Company Is Liquidated and Trust Fund Taxes Are Still Due

There could be an instance in which a company files bankruptcy, is liquidated, and now no longer exists. Some wrongly think the taxes due will just go away.

Instead of the taxes being forgotten, the IRS will then search for the responsible parties. A responsible party is typically defined as someone who is an officer at the company and has the ability to sign checks.

Now, let’s assume that the IRS has found a responsible party. The options can vary and may include one of the following:

• File an Offer In Compromise. In this scenario, the responsible party will state their assets and income and estimate what money they will have available after living expenses during the next five years. This is not a popular option among attorneys and clients because they are a lot of work and a satisfactory compromise, from the individual’s perspective, is hard to reach. .
• Enter into an installment agreement and make regular payments. This is an agreement where the responsible party admits to owing the total amount the IRS requests and allows the responsible party to pay money to the IRS over time in installments. The IRS will then have the ability to garnish bank accounts directly, typically withdrawing monthly installments.
• Run and hide. This is exactly what it sounds like. If the responsible party does not have the money to pay, they may opt to permanently leave the country. Some people choose to find jobs overseas where they can function. However, if the amount owed is large and criminal, the Internal Revenue Service can seek extradition.

Technically, the IRS has a 10-year collection statute in which they have to collect or reduce the assessment to a judgement. If it is a relatively small amount owed, it is possible the IRS will choose not to pursue you.  Should the amount owed be between $50 million and $100 million, they likely will pursue you. The clients we see are often held personally liable to amounts between $1 – $25 million. Often, international relocation is not an option – these clients have family and personal responsibilities in the USA, or the idea of leaving their home is unfathomable. Staying and dealing with the debt may mean having to give up 50% of their social security checks to the IRS every month.

The bottom line is that if employers do not realize the impact of unpaid employment trust they may be penalized heavily for it. Companies should pay over the trust fund taxes as soon as they are due and make it their priority to do so before the court can take that ability away from them.

If you are business owner, current or former, and you are dealing with personal liability for unpaid employment trust taxes, a reputable tax attorney can assist.

By Harold "Hap" May, P.C. on May 10, 2024   /   Uncategorized   /   Leave a comment