Tax Lawyer Blog

A Blog written by the Tax Attorneys for Individuals and Businesses

"Good Motives" are Not an Excuse for Unpaid Employment Taxes

A recent Texas case clearly demonstrates how unforgiving the courts can be when it comes to unpaid employment taxes.

McClendon v. U.S.

In May of 2009, Dr. Robert McClendon learned that the Chief Financial Officer of his medical practice had been embezzling money from him, and that his practice owed roughly $10 million in unpaid employment taxes to the government. McClendon loaned $100,000 of his personal funds to the practice to pay his May 15, 2009 payroll, closed the practice and remitted its receivables to the IRS to help pay down the tax liability.

Tax penalties under 26 U.S.C. § 6672 were assessed at $4,323,343.70. McClendon paid a small percentage and then sued the government for a refund and abatement of the balance.

Trust fund taxes belong to the U.S.

Under 26 U.S.C. § 3102(a) and 26 U.S.C. § 3402(a), employees are obligated to withhold social security and income taxes from their employees' wages. These taxes are held in trust and must be paid over to the government, or the employer faces a penalty equaling the entire amount of the unpaid taxes.

The Section 6672 Penalty

The Section 6672 Penalty may be imposed on any "responsible person" who willfully fails to collect, account for, and pay over trust fund taxes. McClendon agreed that he was a responsible person for his practice, but argued that his failure to pay the back taxes to the IRS was not willful:

  • First, McClendon claimed that his loan to the practice was limited to payroll payments, and that the funds were therefore encumbered. The court disagreed, ruling that allowing responsible persons to evade a finding of willfulness and liability through preferential lending arrangements would "undermine the purpose of § 6672 in assuring that trust fund taxes are paid to the government."
  • Second, McClendon attempted to use the "reasonable cause" defense by arguing that he acted "morally and generously" by using his personal funds to pay the medical practice’s staff. The court did not accept this argument either, stating that good motives will not exonerate a taxpayer who "consciously decides to use unencumbered funds to pay a creditor other than the government."

The court acknowledged that Dr. McClendon's motives were admirable, but clearly stated that they were still not legally relevant.

San Francisco Employment Tax Attorneys

McClendon’s medical practice was finished by theft, mismanagement and a tax dispute. Tax issues have destroyed many businesses. Don’t let it happen to yours. Contact the employment tax attorneys at Moskowitz, LLP today.

Common Triggers of C-Corporation Tax Audits

We are seeing an increase in the IRS auditing corporations.   There are a number of reasons why the IRS will choose a particular corporate tax return for an audit – here are some common triggers that can help you stay off the IRS radar:

Payroll, payroll, payroll

The IRS is well aware that many businesses give in to the temptation of using payroll tax money for operating expenses. Payroll taxes are your employees’ share of federal tax, FICA and Social Security/Medicare and these amounts do not belong to your business.  The funds must be safeguarded and when due, turned over to the federal government.

The IRS will also scrutinize attempts to circumvent payroll altogether. For example, substantial loans to corporate officers with correspondingly low payroll figures is a red flag – it may indicate that the company is engaged in an abusive scheme to avoid payroll taxes.  In these cases, the IRS may re-characterize officer loans as payroll, with significant tax, interest and penalties imposed on the company. Note also that the IRS may also look for a 1099-Int to confirm that the corporation received interest on all loans paid to an officer.

Excessive and unauthorized deductions made on a corporate tax return

A corporate tax return may be selected for audit on the basis of a computerized numeric score that is outside the statistical norm, as generated by the Discriminate Function System (DIF). Deductions for meals, travel, automobile expenses, business entertainment, charitable donations, salaries/bonuses, health insurance and other fringe benefits that are out of proportion will give the company a higher score, resulting in the IRS giving it a more careful look.

Personal expenses billed to the company

The IRS is watchful of the following:

  • Corporations that include an officer’s personal use of a leased vehicle on their W-2.
  • Contractors that bill their companies for improvements made on their personal residences.

Make sure that all meals, travel, entertainment and the like that are billed to the company satisfy the “business purpose test” – if there is no substantial business purpose to the transaction, the deduction will be denied.

Poor recordkeeping

Poor recordkeeping can easily lead to an IRS audit. If the corporate books don’t balance, the tax return entries won’t balance. W-2 forms and 1099 interest statements need to match income reported on the tax return. Retained earnings must be rolled forward to the next year. A retail business should not show an unreasonably low ending inventory. A company should have a good reason for any significant deviation in its profit margins and expense ratios from previous years. These are all red flags for the IRS that show a lack of attention to detail and/or possible absence of records to substantiate the company’s expenses.

Tax forms not timely filed

The IRS will question the accuracy of your books if any of your tax forms are not filed in a timely fashion. This includes:

  • Annual 1120 U.S. Corporation Income Tax Return 
  • Annual 940 Employment Tax Return
  • Form 941: Employer’s Quarterly Federal Tax Return
  • 1120-W Estimated Tax for Corporations
  • 1096 Annual Summary and Transmittal of U.S. Information Returns, along with 1099s

Full service tax law firm in San Francisco

The tax attorneys, CPAs, Enrolled Agent and support staff at Moskowitz, LLP provide individual taxpayers and businesses with unparalleled efficient and comprehensive representation in all phases of tax controversy and litigation. Contact our office today for a consultation.