I have a strict attendance policy in that a student is either either there or not. I don't do excused absences. Students get six absences with no penalty and with no questions asked. Their seventh absence, however, results in a one-increment reduction of their final grade (B+ to B, e.g.), again with no questions asked. Further absences lead to more severe consequences.
One year, a student who had missed six classes came to me and asked if I would excuse him for a seventh absence. He was a key member of his University’s Cheer Squad and he would have to miss class in order to participate in their State finals competition.
I explained to him the concept of a hard choice: a situation where any decision carries some significant downside. But the difficulty of the choice would not excuse the penalty. I suggested that he consider what would be more important to him in 10 years: getting a lower grade in one law school course, or missing the chance to help his team win a State championship. He decided to take the grade hit. Good choice, IMHO.
In Pamela Cashaw v. Commissioner, T.C. Memo. 2021-123 (Oct. 27, 2021) (Judge Greaves), we learn that taxpayers cannot be excused from the §6672 Trust Fund Recovery Penalty just because they face hard choices on how to use their company’s limited cash, no matter how sympathetic we may be to their difficulties. If they have funds to pay the taxes withheld from their employees’ paycheck, their choice to instead pay off more immediately threatening creditors opens them to personal liability for the unpaid trust fund taxes. Details below the fold.
The Law: The §6672 Trust Fund Recovery Penalty
Section 3402(a) makes every employer responsible for collecting their employees' income taxes by withholding an appropriate amount from each paycheck. Section 3102(a) imposes a similar requirement for the employees’ share of social security taxes. These withheld taxes are known as "trust fund" taxes because §7501(a) says that the money so collected is held in trust for the United States until it is paid over. Employers are supposed to remit these withheld taxes on an ongoing basis and to account for the payments and withholding once each quarter on Form 941.
If the employer fails to properly pay over these withheld amounts to the government, then the Treasury suffers a loss, because §31(a) gives employees a credit for taxes withheld regardless of whether the money actually reaches the government's coffers. I call this the “duh” credit because even though the government may not have received the money, you can just hear the employee saying, “well, duh, I paid it when it was withheld.”
Section 6672 is designed and administered to help ensure collection of trust fund taxes. It provides that the Service may impose a penalty on any person who "willfully” fails to collect, account for, or pay over the trust fund taxes they are responsible for. The penalty amount is 100% of the tax owed. That is why the provision used to be called “the 100% penalty.”
Though §6672 is called a "penalty," the Service’s Policy Statement 5-14 says it’s really a tool to collect the missing trust fund taxes: “The withheld income and employment taxes or collected excise taxes will be collected only once, whether from the business, or from one or more of its responsible persons.” So perhaps that is why the penalty is now called the Trust Fund Recovery Penalty (TFRP). Its purpose is to recover the trust fund taxes that ought to have been paid; it’s not used to fine or punish the responsible person. Thus, if multiple individuals are liable for the penalty for the same unpaid taxes, the IRS will cross-apply payments from one against the accounts of all who have been assessed. See IRM 5.7.7
Courts give the term “willfully” a very broad meaning, in large part because of this policy to use the provision as a collection device and not to punish. I discuss that in "Lesson From The Tax Court: §6672 Trust Fund Recovery Penalty Is Really A Penalty...Sort Of," TaxProf Blog (Jan. 27, 2020).
One of the best summaries of how courts interpret “willfully” comes from McClendon v. United States, 892 F.3d 775, 783 (5th Cir. 2018):
“Willfulness under §6672 requires only a voluntary, conscious, and intentional act, not a bad motive or evil intent. It may be proved in two ways. First, willfulness may be proved by evidence that the responsible person (1) had actual knowledge that the business was delinquent on its withholding taxes but (2) used the business's unencumbered funds to pay the business's non-IRS creditors anyway. Funds are considered encumbered if they are subject to restrictions imposed by a creditor holding a security interest in the funds which is superior to any interest claimed by the IRS, and those restrictions preclude a taxpayer from using the funds to pay the trust fund taxes. When willfulness is founded upon this method, the responsible person's liability under §6672 is limited to the amount of available, unencumbered funds deposited into the business's bank accounts after the responsible person became aware that the accrued withholding taxes were due.”
“Willfulness may also be proved by evidence that the responsible person acted with a reckless disregard of a known or obvious risk that trust funds would not be remitted to the Government. A responsible person, for example, acts with reckless disregard by failing to investigate or to correct mismanagement after being notified that withholding taxes have not been duly remitted.” (internal quotations and citations omitted).
The Tax Court does not get many opportunities to interpret §6672 because most taxpayers who contest that assessment simply pay a small portion of the liability, then sue for refund in federal district court. However, the CDP process permits taxpayer to contest the liability being assessed if they did not actually get an opportunity to do so before the assessment. That’s what happened in today’s case and so we get this lesson on what “willfully” means. Let’s take a look.
Ms. Cashaw was in the wrong place at the wrong time. She had worked at the storied Riverside Hospital in Houston for many years, starting as a pharmacist and eventually flipping into hospital administration. In October 2012, Riverside’s CEO, Earnest Gibson, III, was arrested and charged with Medicare fraud. He was later convicted. Ms. Cashaw was appointed acting head of the Hospital. The proverbial buck now stopped at her desk and she was in charge of overseeing Hospital operations, including making decisions about who got paid what. As part of that authority, she signed Riverside’s checks.
She optimistically posted this appeal for “New Beginnings” on the Riverside website.
The New Beginnings never began. Riverside hit a financial wall. First, the Centers for Medicare & Medicaid Services (CMS) became...oh...let’s say “reticent” about paying claims associated with Riverside. Second, the hospital’s biggest creditor, Dixon Financial Services, sued and forced the hospital to sign agreements—called “rule 11 agreements”—giving Dixon substantial control over spending decisions.
Ms. Cashaw, however, was still the one making day-to-day decisions about spending. Judge Greaves explains that she “attempted to prioritize payments, sometimes against the terms of the rule 11 agreements, among the hospital’s staff, vendors, and private creditors that she deemed provided ‘essential patient care services.’ This prioritizing included her refusal at times to sign checks on behalf of Riverside where the purported purposes of the payments did not align, in her eyes, with such patient services.” Op. at 4.
In April 2014 Riverside closed the main hospital and Ms. Cashaw effectively left her position. In 2015 Riverside went into bankruptcy. Meanwhile, the IRS opened a TFRP investigation and in July 2015 made a large TFRP assessment against Ms. Cashaw for three different quarters: the 3rd quarter of 2013 (ending September 30); the 1st quarter of 2014 (ending March 31), and the 2nd quarter of 2014 (ending June 30). If you are wondering why the IRS did not ding her for the fourth quarter of 2013, keep on reading.
The opinion does not say the total amount, but does say that the TFRP assessment for just the last quarter, ending June 30, 2014, was about $168,000. Op. at 2, note 2. Assuming similar liabilities for the other two quarters, it looks like Ms. Cashaw was facing a total liability of around $350,000. Because she had been unable to contest the liability before it was assessed, she was allowed to contest it in a CDP hearing. Appeals abated some $142,000 of the liabilities for that quarter, presumably because Ms. Cashaw had left in April. Ms. Cashaw thought she should not be responsible for the rest, either.
Let’s learn why she was unable to avoid that liability.
Lesson: Even Hard Choices Are Intentional: They Don’t Let You Off The TFRP Hook
Recall that to be liable for the TFRP a person must first have had the authority to withhold, account for, or pay over the trust fund taxes. Judge Greaves had no difficulty finding Ms. Cashaw had the duty. She was, after all, in charge of the Hospital.
That brings us to willfulness. A person who has the authority is nonetheless liable only if they willfully fail to carry out their duty. The bigger issue here was whether Ms. Cashaw had willfully failed to pay trust fund taxes. Recall willful simply means the taxpayer acted intentionally. There is no bad motive required. But they will not be willful if they do not have the funds with which to pay the taxes. That might happen if there was a court order freezing funds, or if a lender had superior claim to the funds because of a security agreement. See the long quote from McClendon, supra.
Ms. Cashaw first argued that she was not willful because she did not have funds to pay the taxes. She said that once the Dixon Financial had sued and subjected Riverside to various “rule 11 agreements,” those agreements controlled what Riverside could do with its monies. Oh, and there was also a 2009 security agreement with Dixon. Oh, and there was at least one state court order freezing Riverside’s bank account.
Judge Greaves was not impressed. As to the rule 11 agreements he noted that: (1) the agreements did not give Dixon superior lien rights; (2) “at least one rule 11 agreement stipulated for the payment of trust fund taxes”; and (3) Ms. Crenshaw ignored the agreements anyway whenever she thought it was necessary to provide for essential patient services. As to the security agreement, it explicitly yielded priority to payment of taxes. And as to the court order, the only order Ms. Cashaw could produce did not cover the quarters at issue. It froze Riverside’s bank accounts from November 1, 2013 to December 6, 2013. Do you see now why the IRS probably did not ding Ms. Cashaw for the fourth quarter of 2013?
Ms. Cashaw next argued that she did not act willfully because she was caught between a rock and a hard place. She claimed that certain Texas state statutes created personal liability if she willfully failed to pay for essential patient services. Since there was simply not enough money to go around, she had to make the hard choice of being exposed to liability under the federal statutes or liability under the state statutes.
Judge Greaves was again nonplussed. He pointed out that the state statutes did not, in fact, impose personal liability. And “even if we were to read these State code provisions to conflict with section 6672, the Federal statute necessarily preempts the State code in this instance.” In short, it appears Ms. Cashaw had been ill advised on the scope and effect of the state statutes.
Finally, Ms. Cashaw explained that she had made her choices for the best interests of the hospital’s patients. Riverside Hospital’s patients were mostly from grossly under-served neighborhoods. Keeping the Hospital operational was vital not only for the well-being of individual patients but also for the surrounding community.
But a choice is a choice, even if it’s hard. TFRP liability requires both power and willfulness. Here, there was both. Judge Greaves writes “Petitioner concedes that she knew withholding taxes for Riverside were due. Additionally, the record contains considerable evidence that she paid other creditors after becoming aware of Riverside’s unpaid liability for Federal employment taxes.” Op. at 18.
That’s what willful means: a knowing, intentional failure. Ms. Cashaw had the best of intentions, the best of motives, and there is no doubt she faced terribly hard choices. But even hard choices are intentional. As Judge Greaves writes: “Her stated justification, no matter how noble, does not make her failure to pay any less willful.” Id.
Coda: It appears that Riverside Hospital may reopen. In 2018, Harris County purchased the Hospital with help from the Houston Endowment. This article says the renovation plans would take six or seven years. No doubt COVID interrupted those plans. Certainly, there is nothing about reopening on Riverside’s intermittently functional website, which appears not to have been updated since Ms. Crenshaw left.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law. He invites readers to return each Monday for a new Lesson From The Tax Court.