In times of financial crisis, many businesses succumb to financial pressures and “borrow” from employees’ tax withholdings to pay other creditors.  To some, this seems like a viable alternative to meet short-term cash needs, keep the lights on, or service existing debt.  Unfortunately, for many struggling businesses, circumstances never significantly improve and tax withholdings are not restored.  Even worse, the IRS eventually assigns a revenue officer to collect the overdue taxes from the business and assesses responsible individuals with the Trust Fund Recovery Penalty (“TFRP”) – a personal liability.  Those assessed with the TFRP are often stuck with a substantial liability that cannot be easily repaid and is not dischargeable in bankruptcy.

Some businesses with TFRP issues may still be viable and financial circumstances can be improved with new leadership, better financing terms, or other managerial changes.  However, before taking steps to acquire or restructure a business with employment tax issues, careful consideration of lingering TFRP issues must be undertaken.  Slodov v. United States, 433 U.S. 238 (1978) exemplifies a cautionary tale.  In that case, the United States pursued the collection of the TFRP from new management of a corporation that owed outstanding trust fund taxes, which arose under prior management.  At the time of transition, no liquid assets were available to pay the outstanding trust fund taxes.  The Supreme Court held that one who uses after-acquired funds (or revenues) to pay other operating expenses of the business, rather than the prior withholding taxes, is not automatically personally liable for the TFRP under I.R.C. § 6672; however, if funds are available when responsibility is assumed (i.e., upon acquisition or change in management) and those funds are not used to pay outstanding trust fund taxes, that person may be held liable to the extent of the funds that were available at that time.  The taxpayer has the burden to show that no unencumbered funds were available for payment to the IRS.  This is frequently referred to as the unencumbered funds theory.

What can be learned from Slodov?  First, the IRS does not necessarily know who was responsible for the non-payment of taxes and may seek to assess the TFRP from new ownership even if they were not actually responsible.  (Proving lack of responsibility or lack of willfulness can require a substantial legal defense.)  Second, the IRS will attempt to assess new ownership with responsibility (and liability for the TFRP) to the extent of any available funds at the time of the transition.  And, third, the IRS will attempt to assess the TFRP against as many parties as possible to keep collection options open.

In order to avoid potentially adverse consequences, those acquiring a business or assuming management responsibility should perform due diligence to ensure that no taxes are outstanding when they assume authority.  If such liabilities exist, they should insist that these obligations be paid in full prior to acquisition or assuming authority.  It is not enough for a purchaser to attempt to contract away liability by agreement – cases indicate that such agreements are not effective to avoid potential liability as they would frustrate the purposes of the TFRP provisions.  See, e.g., Markel v. United States, 70-2 USTC ¶9702 (W.D. Tex. 1970) (stating that TFRP liability cannot be assigned); Collins v. United States, 92-2 USTC ¶50,351 (E.D. Mo. 1992) (holding that agreement could not relieve liability as IRS is a third-party beneficiary).  (On the other hand, if a seller transfers liability for trust fund taxes by agreement and sufficient liquid assets to satisfy such liabilities exist at the time of transfer, liability for TFRP may exist for the purchaser but not the seller.  See Feist v. United States, 607 F.2d 954 (Ct. Cl. 1979) (where seller gained oral assurances from purchaser that liabilities would be satisfied).)  If the liabilities cannot be satisfied, consideration should be given to structuring the acquisition as an asset purchase rather than a stock purchase.  Even if an asset sale is performed, purchasers should be careful to ensure that the IRS cannot pursue liability on the basis of transferee liability or alter ego liability.

In a similar vein, those purchasing or assuming control of businesses with unpaid state income tax withholdings, sales and use taxes, or certain other state taxes can be exposed to personal liability for those liabilities.  For example, in Maryland, Tax-General § 10-906(d) imposes personal liability for tax withholdings on officers or agents who exercise control over fiscal management of a business.  Rather than performing an exhaustive investigation, taxing authorities may simply review tax returns (and other compulsory state filings) to determine those individuals in control.  In many cases, this can result in a proposed assessment against those having little, if anything, to do with the unpaid liabilities.  Precautionary steps, such as those relevant to the TFRP, should be taken during any transitional period of a business to minimize the risks of an unexpected assessment of personal liability.

Individuals facing potential trust fund tax compliance issues should immediately seek assistance from a qualified tax professional.  Brandon N. Mourges and the tax controversy team at Rosenberg Martin Greenberg LLP frequently represent businesses and individuals throughout all stages of civil and criminal federal and state tax controversies.  For a free consultation, please contact Brandon at or 410.951.1149.