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Unpaid Trust Fund Taxes Bring Steep Penalties

Original Article by Jennifer Gatherwright | KENTUCKY BENCH AND BAR CONTRIBUTOR

Albert Einstein once said that the hardest thing in the world to understand was the income tax. No doubt this is an opinion still shared by many. Although the GOP’s 2018 Tax Cuts & Jobs Act promised to make taxes simple enough to fit onto a postcard, it did not significantly address the government’s inability to collect all of the taxes that are due. The difference between what the government is owed in terms of tax dollars and what it actually collects is called the tax gap. The most recent Internal Revenue Service (“IRS”) statistics show the gross federal tax gap as composed of three components: (1) non-filing, (2) underreporting, and (3) underpayment. The estimated gross federal tax gaps for these components are $32 billion, $387 billion, and $39 billion, respectively. The gross tax gap estimates can also be grouped by type of tax. The estimated gross tax gap for individual income tax alone is $319 billion.

As an attorney who has represented distressed taxpayers for nearly 20 years, I am occasionally asked whether a national sales tax combined with the elimination of the income tax would fix the tax gap and put me out of a job. My answer is always the same – my clients still won’t pay. This response verges on smart-alecky, and I am often entertained by the reaction it gets. However, it is rooted in a deep and serious understanding that business taxpayers are not necessarily more tax compliant than individual taxpayers. In fact, the estimated gross federal tax gap for employment taxes commonly referred to as “payroll taxes,” is $91 billion. In many respects, shifting the responsibility to collect taxes to retailers would simply shift the tax gap away from individuals and onto businesses.

Trust Funds

As a general rule, Kentucky employers are already required to withhold, report, and remit both federal and state payroll taxes for their employees. Kentucky retailers are also required to collect, report, and remit Kentucky sales tax. However, many cash-strapped companies fail to remit sales and payroll taxes owed to the government because unlike other creditors, taxing authorities are not knocking on the door demanding their money until months or years after the payment due date. I have had only a few clients park their Ferraris out front when coming to see me about unpaid payroll taxes! More often than not clients are using the money to satisfy trade obligations or meet payroll rather than acting with bad intent. Unfortunately, this strategy can generate exposure to substantial civil and criminal penalties.

If companies do not pay their payroll or sales taxes, the individuals involved may become liable for the tax as a “trust fund” and become an alternative source of collection for the government. If numerous people are involved in the business, it may be difficult for the practitioner to determine who is individually liable for the trust fund taxes and whether the liability will be strictly civil or perhaps criminal as well.
Internal Revenue Code (“IRC”) § 6672 provides the federal mechanism for imposing the trust fund penalty on individuals associated with a company. It states:

Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall . . . be liable to a penalty equal to the total amount of the tax evaded, or not collected . . . and paid over.

The two key requirements of IRC § 6672 are: (1) the individual must be a “responsible person” required to collect, account for, and pay over taxes; and (2) the individual must “willfully” fail to perform this duty. This federal test generally results in a fair and reasonable identification of the individuals with liability for unpaid taxes.

A determination of “responsibility” depends upon the facts and circumstances of each case. Common factors in finding “responsibility” include: (1) identification of the person as an officer, director, or principal shareholder of the corporation, a partner in a partnership, or a member of an LLC; (2) duties of the officer as set forth in the by-laws; (3) authority to sign checks; (4) identification of the person as the one in control of the financial affairs of the business; (5) identification of the person who had authority to determine which creditors would be paid and who exercised that authority; (6) identification of the person as the one who controlled payroll disbursements; and (7) identification of the person who signed the employment tax returns.

A responsible person may be an officer, director, shareholder, or some other person with sufficient control over the funds to direct disbursement of such funds, including employees, accountants, bookkeepers, lenders, payroll service providers, professional employer organizations, and contractors. Examples of responsible persons, as determined by the courts, include: an accounting firm that manages the financial affairs of a farmers’ cooperative on a daily basis; a controller who has authority over the dispersal of funds and priority of payments to creditors; a prime contractor who, out of necessity or by contract, pays net wages directly to employees of a subcontractor that is having financial problems; an equity firm that supplies working capital to a corporation to pay net wages with the knowledge that the corporation is not remitting payroll taxes to the government; a bank lender that honors a customer’s payroll checks drawn in excess of the credit line.

The federal courts define “willfulness” for purposes of the trust fund as intentional, deliberate, voluntary, reckless, knowing (not accidental). No evil intent or bad motive is required. To show “willfulness,” the government must show that the responsible party was aware of the outstanding taxes and either deliberately chose not to pay the taxes or recklessly disregarded an obvious risk that the taxes would not be paid. The payment of net wages (wages minus trust fund taxes) to employees when funds are not available to pay withholding taxes is a willful failure to collect and pay over under IRC § 6672. For purposes of determining willfulness, an employee owed wages is merely another creditor of the business, and preferences to employees over the government constitute willfulness.

In contrast to IRC § 6672, the Kentucky trust fund statutes for payroll tax, Kentucky Revised Statute (“KRS”) § 141.340, and sales tax, KRS § 139.185, do not contain the term “willful.” Furthermore, while IRC § 6672 identifies the responsible person as a “person required to collect, truthfully account for, and pay over any tax imposed,” both KRS §§ 139.185 and 141.340 expressly identify the responsible persons as being “the president, vice president, secretary, treasurer or any other person holding an equivalent corporate office of any corporation” or “the managers of a limited liability company, the partners of a limited liability partnership, or the general partners of a limited liability limited partnership.” Consequently, the Commonwealth’s investigation into the trust fund is almost always limited to looking at the company’s officers.

Both KRS § 141.340 and KRS § 139.185 contain the caveat, “No person shall be personally and individually liable under this subsection who had no authority to collect, truthfully account for, or pay over any tax imposed by this chapter . . . .” However, the Commonwealth interprets this language broadly and assumes that all officers have such “authority” by statute or bylaws, regardless of who actually runs the day-to-day operations of the business or the identity of those on the bank account signature cards. Rebutting the Commonwealth’s presumption of “authority” is a Sisyphean task, but it can be done if the officer can provide bylaws or an operating agreement setting forth that the officer’s position in question is specifically without authority to collect, account for, or pay taxes, as well as show that the officer in question was not on the bank signature card and did not run the day-to-day operations of the business.
Potential Criminal Violations

The IRS and United States Department of Justice (“DOJ”) are more vigorously pursuing payroll tax violations and referring more cases for criminal prosecution. In April 2016, the DOJ emphasized that the failure to comply with federal employment tax obligations is “not simply a civil matter” and employers who treat amounts withheld from employees’ wages as their own property “are engaging in criminal conduct and face prosecution, imprisonment, monetary fines, and restitution.” In 2016, language describing IRC § 7202 as “a felony that is infrequently prosecuted” was also conspicuously removed from the Federal Sentencing Guidelines. The most recent IRS statistics show the government’s Fiscal Year 2016 conviction rate for those indicted for tax crimes was 96.77%, and the incarceration rate for those convicted was 79.9%.

IRC § 7202 authorizes the IRS to impose criminal penalties on those who do not remit payroll taxes. IRC §7202 states that any person required to collect, account for, and pay over payroll taxes who willfully fails to collect or truthfully account for and pay over such tax shall be guilty of a felony and, upon conviction thereof, shall be fined not more than $10,000, or imprisoned not more than 5 years, or both.

Although Kentucky has specific felony criminal penalties for the failure to remit taxes, the Commonwealth almost always charges sales and withholding tax offenders with the more general crime of theft by failure to make required disposition of property. For prosecutors, the burden of proof is much lower under KRS § 514.070, and — to the taxpayers’ benefit — this statute also allows for misdemeanor charges in certain cases. KRS § 514.070 states that a person is guilty when:
(a) He obtains property upon agreement or subject to a known legal obligation to make specified payment or other disposition whether from such property or its proceeds or from his own property to be reserved in equivalent amount; and (b) He intentionally deals with the property as his own and fails to make the required payment or disposition.

Theft by failure to make required disposition of property received is a Class A misdemeanor unless the value of the property is: (a) Five hundred dollars ($500) or more but less than ten thousand dollars ($10,000), in which case it is a Class D felony; or (b) Ten thousand dollars ($10,000) or more, in which case it is a Class C felony.


Many practitioners who counsel business clients are familiar with the challenges that can arise when sales and payroll taxes are not turned over to the government. Unpaid taxes can wreak havoc on a marriage, put companies out of business, and land its owners in bankruptcy or worse, prison. Practitioners serve their clients well by stressing the importance of staying compliant with employment and sales tax obligations. When delinquency occurs, practitioners should help their clients resolve the situation before the government takes action.

This article originally appeared in the Kentucky Bench & Bar Magazine May/June 2019 issue. CLICK HERE to download the May/June 2019 PDF.



  1. See Tax Form Baffles Even Prof. Einstein, N.Y. Times, Mar. 11, 1944, at A1.
  2. Pub. L. No. 115-97, 131 Stat. 2054 (codified in scattered sections of 26 U.S.C.).
  3. See, e.g., Kelly Phillips Erb, Treasury Says New Postcard-Size Tax Return To Be Released Next Week,
  4. Forbes, Jun. 21, 2018,
  5. Internal Revenue Serv., Tax Gap Estimates for Tax Years 2008-2010, Attach. 2, Table 2 (April 2016),
  6. Id.
  7. Id.
  8. I.R.C. § 6672(a).
  9. Internal Revenue Manual, sec. (July 18, 2012).
  10. Quattrone Accountants, Inc. v. IRS, 895 F.2d 921, 927 (3d Cir. 1990).
  11. Looney v. United States, 544 F. Supp. 2d 574 (S.D. Tex. 2008).
  12. United States v. Algernon Blair, Inc., 441 F.2d 1379, 1381 (5th Cir. 1971).
  13. United States v. Intercontinental Indus., 635 F.2d 1215, 1218-19 (6th Cir. 1980).
  14. Fidelity Bank, N.A. v. United States, 616 F.2d 1181, 1184 (10th Cir. 1980).
  15. See Domanus v. United States, 961 F.2d 1323, 1325-27 (7th Cir. 1992).
  16. Phillips v. IRS, 73 F.3d 939, 942 (9th Cir. 1996).
  17. Hochstein v. United States, 900 F.2d 543, 548 (2d Cir. 1990).
  18. Ky. Rev. Stat. §§ 139.185(1), (2), 141.340(2), (3).
  19. Press Release, U.S. Dep’t of Justice Office of Public Affairs, Justice Department Reminds Employers of Their Employment Tax Responsibilities (Apr. 27, 2016) (available at
  20. Amendments to the Federal Sentencing Guidelines at 48 (Nov. 1, 2016).
  21. Internal Revenue Serv., Current Fiscal Year Statistics,
  22. Ky. Rev. Stat. § 141.990(5).
  23. Ky. Rev. Stat. § 514.070.
  24. Id. § 514.070(1), (4).