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Can Business Owners be held Personally Liable for Non-Trust Fund Federal Taxes?
Posted in Litigation

It is presumably widely known in the small business community that “responsible persons” can be held personally liable for not paying trust fund taxes to the federal government. A “responsible person” is one who controls the payment of funds within the business as distinguished, for example, from an accounts payable clerk who simply follows orders on which creditor to pay when and how much. But is it possible that a “responsible person” could be held personally liable for non-trust fund federal taxes, as well?

Trust fund taxes are funds withheld from an employee’s wages (including for income taxes, social security and Medicare taxes due by the employee) and held in trust by the employer to be paid by the employer directly to the taxing authority. Another common, but not federal, trust fund tax is sales tax collected by a merchant to be remitted by the merchant to the taxing authority. Often the filing of a business bankruptcy – especially a Chapter 7 liquidation as opposed to a Chapter 11 reorganization – is timed to make certain that trust fund taxes due by the business debtor are paid so that the responsible person will not be exposed to having to personally pay them.

The U.S. District Court in Indianapolis held earlier this year that a responsible person was personally liable for both federal employment and unemployment taxes due by his company. Specifically, the court found that, because Phillip Sperry directed payments to other creditors of his company during the time the taxes were due and while the company was insolvent, he was personally liable for both kinds of federal taxes. That liability is based on a federal statue which provides “A claim on the United States Government shall be paid first” when the taxpayer is insolvent and “an act of bankruptcy is committed.” The court defined “an act of bankruptcy” to include paying creditors other than the United States when the taxpayer is insolvent. Further, the court defined “insolvent” as when a taxpayer’s assets exceed its liabilities and its property is insufficient to pay all its debts. Sperry was held personally liable for payment of these non-trust fund federal taxes.

Whether there is a policy or practice by the United States to monitor Chapter 7 business bankruptcies and pursue responsible persons for unpaid non-trust fund taxes is unknown, but owners of businesses in distress should understand payment of creditors may lead to having to personally pay the United States any tax due by the business.

If you have questions about personal liability as it relates to you or your business, please contact a member of the Bankruptcy and Creditor/Debtor Rights team at Bingham Greenebaum Doll LLP.

DISCLOSURE REQUIRED BY CIRCULAR 230. This Disclosure may be required by Circular 230 issued by the Department of Treasury and the Internal Revenue Service. If this article, including any attachments, contains any federal tax advice, such advice is not intended or written by the practitioner to be used, and it may not be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer. Furthermore, any federal tax advice herein (including any attachment hereto) may not be used or referred to in promoting, marketing or recommending a transaction or arrangement to another party. Further information concerning this disclosure, and the reasons for such disclosure, may be obtained upon request from the author of this article. Thank you.

  • Senior Partner

    Mr. Boydston practices in the areas of bankruptcy (including representation of creditors, debtors and of committees and bankruptcy litigation), receiverships, debtor/creditor relations, and commercial transactions and ...

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