Officers' Reasonable Belief That Taxes Were Paid Precluded Trust Fund Penalty Byrne, (CA 6 5/15/2017) 119 AFTR 2d 2017-762 The Court of Appeals for the Sixth Circuit, vacating and remanding a district court decision that held corporate officers liable for the Code Sec. 6672(a) trust fund penalty, has held that the officers took reasonable steps to ensure the timely payment of trust fund taxes and reasonably believed that the taxes were being paid. The Court also ruled on the standard of review to be applied by Circuit Courts when they determine whether a taxpayer acted willfully under Code Sec. 6672(a). Under Code Sec. 6672(a), if an employer fails to properly pay over its payroll taxes, IRS can seek to collect a trust fund penalty equal to 100% of the unpaid taxes from a person who: (1) is a responsible person i.e., one who is responsible for collecting, accounting for, and paying over payroll taxes; and (2) willfully fails to perform this responsibility. The Sixth Circuit has previously held that a responsible person will be found liable under Code Sec. 6672(a) if the government can demonstrate that he or she had either (1) actual knowledge that the trust fund taxes were not paid and the ability to pay the taxes, or (2) recklessly disregarded known risks that the trust fund taxes were not paid. In other words, for a responsible person to be deemed to have acted willfully under Code Sec. 6672(a), he or she must have either had knowledge of the tax delinquency and knowingly failed to rectify it when there were available funds to pay the government (Gephart, (CA 6 1987) 59 AFTR 2d 87-1099) or deliberately or recklessly disregarded facts and known risks that the taxes were not being paid. (Calderone, (CA 6 1986) 58 AFTR 2d 86-5703) Circuit Courts review trial court findings of fact for clear error and their conclusions of law de novo in an appeal from a judgment entered after a bench trial. (T. Marzetti Co. v. Roskam Baking Co., (CA 6 2012) 680 F.3d 629; Fed. R. Civ. P. 52(a)(6)) Circuit Courts also review de novo ultimate facts and mixed questions of law and fact. (Williams v. Mehra, (CA 6 1999) 186 F.3d 685) Ultimate facts are conclusions of fact which are logically deduced from evidence, i.e., from evidentiary facts. Eagle Trim was an automotive supplier. Its largest client was General Motors and it was largely financed by General Motors Acceptance Corporation (GMAC). The parties relevant to this case were Roger Byrne (1.5% owner; President/General Manager/Board Member), Eric Kus (40% owner; Chairman/CEO/Board Member), and Bernard Fuller (Controller). 1
Both Byrne and Kus had the ability to hire and fire employees, as well as signature authority on all then-existing Eagle Trim bank accounts. Fuller handled the filing and payment of employee trust fund taxes. Eagle Trim hired the CPA firm of Weber, Curtin & Drake, PC (WCD) to conduct its year-end audits and to prepare Eagle Trim's corporate income tax returns. In '99, IRS assessed a $30,000 penalty against Eagle Trim for paying its payroll taxes biweekly instead of weekly. In March 2000, WCD sent a letter to Kus, copying Byrne and Fuller, advising Eagle Trim of deficits in its accounting practices, which WCD had observed while conducting its '99 audit. The letter also stated, however, that WCD's observations did not discover any material weaknesses. WCD recommended in its letter that Eagle Trim hire an assistant controller with an accounting degree. Pursuant to WCD's recommendation, in April 2000, Eagle Trim hired Kelly Gillman, an accountant, to assist Fuller with his duties as controller. In July 2000, Eagle Trim also hired Andrew Jones as Eagle Trim's chief financial officer. Jones reported to both Byrne and Kus on all of the financial aspects of Eagle Trim. Fuller reported to Jones. In October 2000, IRS sent Eagle Trim a notice of a penalty for unpaid trust fund taxes for the first quarter of 2000. David Drake, a WCD partner, met with Fuller to discuss the penalty. Fuller informed Drake that he had failed to pay the trust fund taxes on time because of difficulties associated with Eagle Trim's change to a new bank. Following his conversation with Fuller, Drake sent a letter to IRS, repeating Fuller's explanation for the late trust fund tax deposit and requesting that IRS waive the penalties. On Nov. 10, 2000, Fuller sent a letter to Kus, Byrne, and Jones, describing the IRS penalty, his meeting with Drake, and Drake's request for an abatement of the penalty. WCD issued a clean audit on Dec. 11, 2000, regarding Eagle Trim's financial statements through Sept. 30, 2000, opining that the financial statements presented Eagle Trim's financial position fairly in all material respects. The report found that Eagle Trim was current in the payment of trust fund taxes. Despite WCD's clean audit report, in January 2001, WCD sent a letter to Kus, copying Byrne, Jones, and Fuller, identifying flaws in Eagle Trim's accounting practices observed by WCD in the course of its 2000 audit. The letter included a section devoted to Eagle Trim's failure to pay trust fund taxes in a timely manner in '99 and the first quarter of 2000. Also in January 2001, one of Eagle Trim's lenders discovered that Eagle Trim's financial statements were fraudulently overstated and the company, rather than being profitable, was losing money. Fuller had greatly overstated the company's receivables. Eagle Trim entered into a Forbearance Agreement with GMAC, 2
dated Jan. 31, 2001, under which GMAC hired a crisis management company, BBK, Ltd. (BBK) to manage Eagle Trim. At the time the Forbearance Agreement was executed, Kus and Byrne were unaware that Eagle Trim was delinquent on trust fund taxes for the second, third, and fourth quarters of 2000. In late February 2001, BBK informed Byrne and Kus that Eagle Trim was delinquent on its trust fund tax deposits for the those quarters. On Mar. 1, 2001, WCD sent a letter to Byrne explaining that WCD was recalling its audit reports due to the discovery of Fuller's fraud. Eagle Trim went into bankruptcy in April 2001. Via the bankruptcy proceeding, IRS was paid for the previously unpaid trust fund taxes for the second quarter of 2000. IRS assessed against Byrne and Kus Code Sec. 6672(a) penalties for the third and fourth quarters of 2000. The officers brought suit in district court. The district court found that Byrne and Kus willfully failed to pay Eagle Trim's trust fund taxes for the third and fourth quarters of 2000 and were therefore liable under Code Sec. 6672(a). Byrne and Kus appealed to the Sixth Circuit. Willfulness is an ultimate fact. The Circuit Court concluded that willfulness under Code Sec. 6672(a) is an ultimate fact and therefore reviewed de novo the district court's holding that Byrne and Kus willfully failed to pay Eagle Trim's trust fund taxes. It said that which standard of review applies to the district court's determination that a responsible person willfully failed to pay trust fund taxes was a question of first impression in the Sixth Circuit Court. And it said, while it acknowledged that at least one other circuit had held that the determination of willfulness under Code Sec. 6672(a) is a question of fact i.e., Wright, (CA 7 1987) 59 AFTR 2d 87-467 it believed that, at least in this context, willfulness is a question of ultimate fact because finding that someone was willful requires the application of a legal standard to underlying facts. Byrne and Kus did not challenge the district court's factual findings regarding their conduct; they challenged whether this conduct satisfied the legal standard of willfulness. The officers acted reasonably and therefore did not willfully fail to pay. The Circuit Court held that Byrne and Kus took reasonable steps to ensure the timely payment of the third and fourth quarter 2000 trust fund taxes, that they reasonably believed that the taxes were being paid, and thus that they did not willfully fail to pay the payroll taxes. The Court said that the district court correctly determined that Byrne and Kus did not have actual knowledge that the trust fund taxes were not being paid. The record indicated that Byrne and Kus did not acquire actual knowledge of the 3
delinquency until after the Forbearance Agreement was executed and BBK assumed control of Eagle Trim's finances. The district court's finding that they were reckless largely turned on the reasonableness of their reliance on WCD's guidance and audits. The Circuit Court disagreed with the district court that Byrne and Kus did not demonstrate by a preponderance of the evidence that they reasonably believed that Eagle Trim's trust fund taxes for the third and fourth quarters of 2000 were being paid. The Court said that what constitutes reckless disregard for purposes of Code Sec. 6672(a) is an issue of first impression for the Sixth Circuit Court. It then reviewed the precedents of other circuits. It reiterated its previous holding in Calderone that a responsible person is reckless and therefore willful under Code Sec. 6672(a) when he or she disregards obvious or known risks that trust fund taxes are not being paid to IRS and fails to investigate. However, we must balance the government's prerogative to recover that which is owed with limiting liability for that recovery to those who are personally at fault. While noting that Code Sec. 6672(a) does not have a reasonable cause exception, it adopted the Second Circuit's reasonable cause exception to Code Sec. 6672(a) liability: a responsible person's failure to cause the withholding taxes to be paid is not willful if he believed that the taxes were in fact being paid, so long as that belief was, in the circumstances, a reasonable one. (Winter, (CA 2 1999) 84 AFTR 2d 99-6892) The Circuit Court said that the district court held that Byrne and Kus could not rely on WCD to verify that Fuller had become a responsible taxpayer without making any inquiry into what WCD actually did to review his performance of his payroll tax duties. In support of its conclusion, the district court cited Drake's deposition testimony that, when he drafted the October 2000 letter to IRS concerning the penalty for the first quarter of 2000, he had done nothing to verify Fuller's account of the late payments. The Court said that it is certainly true that Byrne and Kus could have taken any number of additional steps to ascertain the status of Eagle Trim's trust fund tax liability. However, it said, its inquiry was limited to whether their belief that trust fund taxes were being timely paid was reasonable under the circumstances. We will not impose liability on Byrne and Kus simply because they did not independently verify their auditors' reports or Fuller's account of the status of Eagle Trim's tax position. For the reasons stated below, the Court determined that Byrne and Kus took reasonable steps to ensure the timely payment of trust fund taxes and reasonably believed that the taxes were being paid. First, they hired Gillman and Jones to assist and supervise Fuller, respectively. The Court said that, while it was not holding that responsible persons may escape liability under Code Sec. 6672(a) simply because they hired support staff or other officers to review payment of trust fund taxes, these were important 4
considerations in determining whether Byrne and Kus reasonably believed Eagle Trim was making timely payment of trust fund taxes. Second, Byrne and Kus's hiring of WCD an independent, professional accounting firm to assist in tax matters and conduct annual, full-scope audits further demonstrates that they took reasonable steps to comply with all of Eagle Trim's legal tax obligations, including the timely payment of trust fund taxes. According to the district court, because Drake did not say in his October 2000 letter whether he investigated Fuller's story, Byrne and Kus could not reasonably have relied on this letter. That is, the district court's logic was that Byrne and Kus could not reasonably rely on any of WCD's statements after notice of Fuller's prior failures to pay the trust fund taxes on time. The Circuit Court said that, because Byrne and Kus had no prior indication of errors or inaccuracies in WCD's auditing, the Court held that their reliance on WCD's representations was reasonable. Third, while WCD noted in its December 2000 audit report that Eagle Trim had been delinquent in paying its trust fund taxes for the first quarter of 2000, WCD confirmed that Eagle Trim's financial statements were fairly presented in conformity with generally accepted accounting principles. Of course, in March 2001, WCD withdrew its December 2000 audit report following the discovery in January 2001 of Fuller's fraud. Thus, even licensed CPAs, who had performed a full-scope audit, missed Fuller's inaccurate accounting entries. And BBK noted that it took several months to gain an understanding of the full amount of the tax liability. The Court said that it could not say that Byrne and Kus acted unreasonably or held an unreasonable belief that Fuller had begun to pay the trust fund taxes on time, given that WCD, a CPA firm, did not detect Fuller's suspect financial accounting after having performed a full-scope audit and that it took several months for a crisis management firm to determine the exact amount of Eagle Trim's tax liability. The Circuit Court vacated the district court's opinion and remanded for further proceedings not inconsistent with the Circuit Court opinion. 5