The legal metaphor “corporate veil” is doubly a tantalizing legal term of art and an effective marketing tool to illustrate to potential clients the benefits of corporate formation.
But attorneys and their clients should not rely on this emblematic security blanket because the country’s most notorious creditor, the Internal Revenue Service, can slice it to shreds with devastating ease.
Section 6672 of the Internal Revenue Code authorizes the IRS to assess the Trust Fund Recovery Penalty (“TFRP”) against any responsible owner, officer, or other party responsible for collecting, accounting, or paying taxes held in trust by a business. The most common corporate trust fund taxes are employment taxes – withholdings and employee shares of Medicare and FICA – excise taxes, and sales taxes.
The amount of the TFRP is equal to the total trust taxes the business collected but willfully failed to turn over to the IRS. Depending on how far behind the business was on its trust fund taxes, the assessment can easily reach six figures or more.
As is the case with most IRS penalty assessments, “willfulness” is broadly defined to include truly nefarious actions (absconding to Tahiti with the taxes) and comparatively innocuous ones (using the taxes to pay other business liabilities such as wages themselves).
To review, the concept behind the “corporate veil” is that owners and officers of an incorporated entity (Inc., LLC, LLP, etc.) can shield themselves from personal liability for even the business’s willful actions, including contract defaults, most torts, and failure to pay debts, including taxes. When a lawsuit is filed against the business that includes its owners/officers as individual defendants, the daunting burden to “pierce the corporate veil” lies with the plaintiff. This burden is so great that, realistically, only plaintiffs with means or evidence of owner/officer malfeasance will be able to keep the individual defendants from being dismissed.
However, the IRS does not have to overcome this burden to assess the TFRP. This could mean massive personal liability assessments against owners, officers, and even accountants and corporate counsel, who exert control over the taxes held in trust by the business. Here is where the “corporate veil” unravels quickly.
When a business fail to pay its trust fund tax liabilities, an IRS Revenue Officer can be assigned to investigate in as little as 60 days. Once contacted by the Revenue Officer, the business will have a brief opportunity to pay its debts in full, usually 30 days. If it cannot, the Officer will move forward with TFRP assessment.
First, interviews are held between the Revenue Officer and any person involved in the operations of the business. Typically, this includes all business owners and officers. However, the IRS will also seek to assess the TFRP against in-house accountants and attorneys who exhibit “significant control” over the business’s finances. Indeed, in sole proprietorships and closely-held business, the IRS may demand to interview owner/officer spouses, even if the spouse is not affiliated with the business.
Though counsel may represent any individual at the TFRP interview, the IRS will insist on a face-to-face or telephone interview with the alleged responsible party. If the individual fails to agree to this arrangement, the IRS will use its summons authority to compel the individual’s participation.
If the Revenue Officer finds sufficient evidence to assess the TFRP against one or more individuals, the IRS will issue Letter 1153, giving the parties 90 days to petition the United States Tax Court to appeal the assessment. If no appeal is filed, the TFRP is assessed on day 91.
To be clear, no new liability is assessed by the TFRP. Rather, a portion of the business’s liability is shifted to the responsible individuals. However, to the blindsided business owner, this is small comfort given the federal tax liens that may be filed and the potential for IRS levy and garnishment actions. Even if the business closes, the TFRP remains. What’s more, the TFRP, unlike some personal income tax debts, is not dischargeable in a bankruptcy.
Despite the veil’s assumed protections, the only cure for the TFRP is to negotiate a payment plan with the IRS collections department to pay the underlying debt as well as the penalty, a painful process without a catchy metaphor.•