Lesson From The Tax Court: The TFRP Trap For Accommodating Payroll Service Providers

In last week's blog post about Loveland v. Commissioner, we learned that declining the opportunity to go to Appeals for a post-assessment hearing did not bar the taxpayer from raising the non-appealed issue in a later CDP hearing.  This was good for the taxpayer because the declined hearing was non-reviewable whereas the CDP hearing was reviewable (albeit lightly) by the Tax Court.  And we all clapped when the Tax Court remanded the case to Appeals to properly consider the OIC issue and gave Appeals some guidance on how to do that. The Tax Court thought that lesson so important that it made Loveland a reviewed opinion.

This week gives a contrasting lesson.  The contrast will not have you clapping.  This week's case involves the more common lesson that that a pre-assessment opportunity for a hearing with Appeals does indeed preclude the taxpayer from raising the issue in a later CDP hearing.  So it is not a reviewed opinion.  But I also see a second lesson here, about exposure to the Trust Fund Recovery Penalty (TFRP).  I see this case as one about a Payroll Service Provider who went too far in accommodating her client's needs and thereby exposed herself to the TFRP, perhaps needlessly.   This lesson may make you put you hands together, but more likely in prayer for your clients who are in the business of providing payroll services. 

The case is Joanna Kane v. Commissioner, T.C. Memo. 2018-122 (Aug. 6, 2018), and the details, as usual, lie below the fold.  

Law

Section 6672 imposes a penalty on any person who is under a duty to withhold, account for, or transfer taxes owed to the federal government by another person.  These are known as "trust fund" taxes because §7501(a) says that the collected money is held in trust for the United States until it is paid over.  The persons who are under that duty are commonly called “responsible persons.”  You can find a more detailed introduction to §6672 in my August blog post “The Misunderstood Trust Fund Recovery Penalty.” That blog discussed the joint and several aspect of the TFRP.  In today’s blog I want to focus on two other aspects: the procedure for assessment; and the wide scope of the term “responsible person.”

1. TFRP Assessment Procedure

Because the IRS policy is to treat the TFRP as a collection device, the IRS field employees responsible for investigating and recommending TFRP assessments are the Revenue Officers (RO).  The RO investigation process is governed by the Internal Revenue Manual (IRM) in Part 5, Chapter 7, Section 4 (“Investigation and Recommendation of the TFRP”).  I’ll just hit the highlights, focusing on the process and not on the content of the investigation.

TFRP investigations are generally triggered when an RO is working a business collection case.  The IRM tells the RO to investigate the potential TFRP liability of potentially responsible persons.  ROs use the Automated Trust Fund Recovery (ATFR) system to document all their actions.  For each TFRP assessment the RO concludes should be made, the RO must get approval from the RO’s group manager, using Form 4183. If the manager approves, then the RO will give the taxpayer Letter 1153 and Form 2751 (“Proposed Assessment of Trust Fund Recovery Penalty”) along with Pub. 1 (“The Taxpayer Bill of Rights”).

Taxpayers who agree with the proposed penalty can just sign and return Form 2751 in the handy provided envelope. Taxpayers who disagree must send the RO a protest within 60 days of the letter.  If the taxpayer misses the deadline, the RO will generate a Form 2749 (“Request for Trust Fund Recovery Penalty Assessment”) and sends it off to the Campus collection function for assessment.

If the taxpayer timely protests and asks for an appeal, the RO is supposed to review the protest first before sending it to Appeals.  If what the taxpayer submits does not change the RO’s mind, the RO still may not send it to Appeals unless the RO’s group manager agrees to still pursue the TFRP.  If the group manager makes this second approval of the proposed 6672 assessment, the RO prepares the Form 2749 but this time sends it to the Office of Appeals along with the protest materials. At the same time the RO sends the taxpayer Letter 1154 (“Notice of Protest of Trust Fund Recovery Penalty to be Forwarded to Appeals”).

When Appeals gets the file it conducts a hearing, following the rules in IRM 8.25.  Importantly, if Appeals decides to approve the proposed assessment, the taxpayer has no further recourse pre-assessment.  Section 6672 does not provide for any Tax Court or other judicial review of an Appeals decision to make the assessment.  The taxpayer’s next step is to then pay a divisible portion of the assessed penalty (generally being the amount of trust fund taxes for one employee for one pay period), request a refund and, when denied, file a refund suit.  For a lovely explanation of all of this see Chapter 16 in that awesome publication “Effectively Representing Your Client Before the IRS” (7th Ed. 2018).

When the determination to assess is completed, the IRS campus collection employees start the collection process as instructed by IRM 5.19.14 (“Trust Fund Recovery Penalty”).

2. The Wide Scope of “Responsible Person.”

The term “responsible person” is not a statutory term.  Nor is it defined in regulations.  And the Supreme Court expressly declined to define the term the classic TFRP case of Slodov v. United States, 436 U.S. 238 (1978)(go read footnote 7 on page 244).

The IRM is not so shy.  Several IRM provisions use the term “responsible person” and several define what it takes to be a responsible person.  For example, to help Appeals, IRM 8.25.1.3.1 (“Definition of a Responsible Person” ) (09-11-2018) lists all the different types of persons who might have sufficient responsibility to come within the scope of §6672.  Similarly, IRM 5.7.3.3.1 (“Establishing Responsibility”) (08-06-2015) gives RO’s the same list and, in addition, specifies several criteria for determining whether any particular person is responsible.

As is relevant to the case this week, both of those IRM sections extend the scope of “responsible person” to persons other than the employer, notably outside payroll service providers and even employees of those payroll service providers.  It all depends, says IRM 5.7.3.3.1 on the person’s “status, duty, and authority.”  The IRM says that “to determine whether a person has status, duty and authority to ensure that the trust fund taxes are paid” the RO should “consider the duties of the officers as set forth in the corporate by-laws as well as the ability of the individual(s) to sign checks.”  But check-signing authority alone does not a responsible person make.  IRM 5.7.3.3.1.1 is quite clear that “if a person has the authority to sign checks, the exercise of that authority does not, in and of itself, establish responsibility.”  The RO must find some additional indicia of responsibility that enables the RO to conclude “the person had the ability to exercise independent judgment with respect to the financial affairs of the business.”  IRM 5.7.3.3.1 tells ROs to look at a laundry list of authorities that might, when added to check-writing authority, make a person “responsible” for §6672 penalty purposes.

Facts

Ms. Kane was a co-owner and employee of a Payroll Service Provider called Keeping The Books (KTB).  One of KTB’s clients was Focus Rentals, LLC, owned by a Mr. Goldsmith.  Mr. Goldsmith apparently travelled quite a bit for his work and was not very attentive to his business.  But Ms. Kane appears to have been very agreeable and accommodating.  For whatever reason she agreed to accept and use check-signing authority over the Focus business bank account.  She signed checks on behalf of Focus multiple times during 2007-2009.  During that time, however, Focus became delinquent in its employment tax obligation and associated trust fund taxes.

According to the Tax Court, the RO “determined that [Ms. Kane’s] possession and exercise of check-signing authority made her a ‘responsible person’ of Focus.”  Accordingly, the RO secured approval from his group manager via Form 4183, sent Ms. Kane a Letter 1153, and processed her timely protest up to the Office of Appeals.  Appeals sustained the proposed assessment and so the IRS bopped Ms. Kane for $35,000 in unpaid Focus trust fund taxes for six quarters between 2007 and 2009.

The TFRP assessments were in 2012.  In August 2016 the IRS filed an NFTL and Ms. Kane quickly invoked her §6320 CDP rights.  In her request she checked the box that she wanted an OIC based on doubt as to liability because, she said, she was not a responsible person.  However, for whatever reason, Ms. Kane did not pursue the matter.  She did not fill out the OIC forms.  She did not pick up the phone for a scheduled telephone hearing.  But her representative did request a rescheduled hearing and promised she would submit a doubt-as-to-liability OIC.  But both she and her representative blew the rescheduled hearing.  Nor did they provide the information that Appeals requested.

Just radio silence.

But, wouldn’t ya know, when Appeals sent out the Notice of Determination to sustain the NFTL filing, Ms. Kane hopped right back up and timely petitioned the Tax Court, claiming again that she was not liable.

After that, more radio silence.

The IRS filed a motion for Summary Judgment in March 1, 2018, and Ms. Kane made no response on the merits.  So Judge Lauber issued his decision on August 6, 2018, sustaining the NFTL filing, almost two years after the NFTL was filed. Collection Delay Process strikes again!

Lessons

Lesson 1. The Difference Between Pre-assessment and Post-assessment Appeals opportunity

Section 6330(c)(2)(B) permits a taxpayer to contest the liability determination underlying an assessment in a later CDP hearing but only if the taxpayer did not have “an opportunity to dispute such tax liability.”  It is increasingly settled that a pre-assessment opportunity to have an Appeals hearing is the kind of opportunity the statute is talking about.  See e.g. Our Country Home Enterprises v. Commissioner, 855, F.3d 773, 791 (7th Cir. 2017)("Section 6330(c)(2)(B)’s “opportunity to dispute” language encompasses all prior opportunities to dispute liability, including administrative ones.");  Iames v. Commissioner, 850 F.3d 160, 164 (4th Cir. 2017)(“preassessment hearings before the Office of Appeals qualify as “opportunit[ies] to dispute” tax liability.”).  Judge Lauber here applies that lesson to the TFRP context: the pre-assessment opportunity to go to Appeals given in Letter 1153 is also the kind of opportunity the statute is talking about.

The importance of the Loveland decision I blogged about last week is the clarification that a post-assessment opportunity to go to Appeals is not the kind of opportunity covered by §6330(c)(2)(B).  Thus, the failure to go to Appeals to fight for an OIC does not preclude the taxpayer from renewing an OIC offer during a CDP hearing.  

Here, therefore, Ms. Kane could not contest her liability for the Trust Fund Recovery Penalty (TFRP) during her CDP hearing because she had a prior opportunity.  The lesson here is that if your client as a pre-assessment opportunity to go to appeals, your client had better take it.  In contrast, the decision on whether to take advantage of post-assessment opportunities will depend on whether the client has any CDP rights left.  

I have to wonder, however, about Ms. Kane’s head-fake for an OIC.  Assume a taxpayer is barred from directly contesting their underlying tax liability in a CDP hearing.  May that taxpayer submit an OIC based on doubt as to liability?  I would think so because the OIC is a collection alternative.  It’s not a direct assertion of non-liability.  It’s an assertion that if the matter were to be litigated the taxpayer would likely win.  In light of this, it would seem a good practice for taxpayers who have some legitimate argument to (1) take advantage of the TFRP appeals process and if that fails then (2) try for a doubt-as-to-liability OIC post-assessment.   Please tell me if you disagree. 

In Ms. Kane's case, however, it appears doubtful she had any legit OIC to make.  It turns out that the IRS has no record of Ms. Kane filing a federal tax return since 2006.  Golly. That’s a problem for any OIC.  Plus, it is not clear that she had a legitimate argument to avoid being a responsible person.  She was just too nice.  Let's look at that lesson more closely.

Lesson 2: Don’t Be So Nice

If the only power Ms. Kane had was to write checks, that alone would not be enough for her to be a responsible person.  Again, check-signing authority alone does not a responsible person make.  Not only is that what the IRM says, it’s also what the courts say.  See e.g. Geiger v. United States, 583 F. Supp. 1166 (D. Ariz. 1984).  But if her check-writing authority came with the authority to decide which creditors to pay and which to not pay, then that takes her over the line.  It’s one thing to just keep the books.  It’s quite another to get to decide how to spend the client’s funds.

If Ms. Kane had authority to choose what creditors to pay, then the only facts that could save her would be if she could show that the authority was only apparent and not real.  See the great discussion on this point by Judge Allegra in Salzillo v. U.S., 66 Fed. Cl. 23, 34-36 (Ct. Cl. 2005)(curiously, the only free-access copy of the case I can find is on this Russian website).

Let's now assume the best of Ms. Kane and assume she really wanted to help out her client, who was perhaps not as business-oriented as he needed to be.  I remember when I was in private practice how business clients would come for business advice as well as legal.  They would ask for help in matters that were beyond the scope of our attorney-client relationship.  It was often difficult to draw and maintain the proper boundaries.  I bet that happens a lot to many professionals.  Perhaps that is what happened to Ms. Kane.  She just wanted to help this client.  The Tax Court notes, however, that Focus was one of her “important” clients and so it may be she was motivated by perceived self-interest as well.

Even assuming the best, the lesson here is: don’t be nice.  If you are the book-keeper, be the book-keeper.  Do not take on check-writing authority or, if you do, be sure to have some written documentation that you must get a co-signature for amounts over some de minimis amount (which you peg lower than the normal Form 941 liability).

Coda: Before 1998 the IRS did not have to offer taxpayers a pre-assessment opportunity to go to appeals to contest a TFRP. As a consequence, it is my sense that most of the important court opinions regarding the TFRP come from before the 1998 reforms took effect.  The 1998 reforms shuttled to the Office of Appeals many disputes that had formerly resulted in court cases.  As a consequence, the law is now more slow to develop and we keep looking to increasingly old cases to inform current dispute.  I do not have any hard numbers to back this up.  If anyone is looking for a writing project, however, this could be a useful one: a study of the effect of increased administrative review on the development of the law and judicial interpretation of the law.

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School Thereof