Restaurant entrepreneur was liable for trust fund penalty

Charles Erwin v. U.S., (CA 4 1/13/2010) 105 AFTR 2d ¶ 2010-351

The Court of Appeals for the Fourth Circuit, affirming a district court, has held that a restaurant entrepreneur was a responsible person liable for a trust fund penalty under Code Sec. 6672 . The taxpayer, who served as a corporate officer and director, selected business sites, hired and fired employees, and negotiated and personally guaranteed loans and other contracts for the company.
Background. Where an employer fails to properly pay over its payroll taxes, IRS can seek to collect a penalty equal to 100% of the unpaid taxes from a “responsible person,” i.e., a person who: (1) is responsible for collecting, accounting for and paying over payroll taxes; and (2) willfully fails to perform this responsibility. ( Code Sec. 6672(a) )
Facts. Charles Erwin, an entrepreneur who in his lifetime owned or operated at least 60 restaurants, joined with three other businessmen to form GC Affordable Dining, Inc., (GCAD), a franchisee of Golden Corral Franchising System, Inc. GCAD eventually opened and operated five Golden Corral restaurants. Erwin, who at all times owned at least a one-third interest in the company, also served as its director and vice president, secretary, and treasurer. While his business partners also served as directors and officers, two managers oversaw the day-to-day operations, payroll, and accounting. Erwin and his partners personally guaranteed construction and operating lines of credit for GCAD with the bank and secured a construction line of credit for a corporation established as a flow-through real estate holding company for GCAD. Erwin participated in selecting sites for the restaurants and signed lease-related documents for all restaurant locations.
Despite early profits, the GCAD restaurants began to lose money, and Erwin and his partners eventually replaced the two managers. In December of '98, Erwin and his partners learned that Barry and Buddy Light (the Light brothers), who had been hired to handle GCAD's accounting and payroll, had failed to pay the entire quarterly payroll tax withholdings for the third quarter of '98. The partners made a capital call for approximately $150,000 and wired the money to the Light brothers. Erwin, who contributed $95,000 of this, personally instructed the Light brothers not to be late with tax payments under any circumstances. Despite this admonition, the Light brothers failed to pay the payroll taxes for the fourth quarter of '98 in full.
In late '98, Erwin and one of his business partners sent the Light brothers $50,000 for additional payment to a favored food vendor and instructed them not to pay the rent because he would handle it directly. Erwin also negotiated a release for GCAD from obligations under one of its leases. The landlord agreed to send $1.65 million to a company financing GCAD's restaurant building and equipment to cover rents that GCAD owed on that and other leases.
In August '99, Erwin and his two partners learned that GCAD had not paid its withholding taxes in full for the first three quarters of '99. In December of '99, the partners made another capital contribution of $50,000 to help cure these deficiencies, but GCAD never paid the taxes in full. Erwin and his partners continued to employ the Light brothers until February 2000.
After terminating the Light brothers, Erwin took control of GCAD accounting functions, including payroll. GCAD remained current on its payroll withholding payments. In late 2000, Erwin became the 100% owner of GCAD, and shortly thereafter dissolved the corporation. Between August '99 and the close of business in 2000, the GCAD restaurants generated approximately $5 million in sales revenue. Rather than paying the outstanding '98 and '99 tax deficiencies, GCAD continued to pay rent and supplier expenses.
IRS assessed tax deficiencies against Erwin in the amount of the unpaid payroll withholding taxes owed by GCAD for the fourth quarter of '98 and the first three quarters of '99, plus interest.
Appellate Court's conclusion. The Fourth Circuit concluded that, as a matter of law, Erwin was a responsible person under Code Sec. 6672 during the periods at issue. Erwin at all times owned at least one-third of the stock of closely-held GCAD and served as its secretary, treasurer, vice president, and director. He signed loan documents and leases on GCAD's behalf, showing that he shared responsibility for establishing the corporation's financial policy. He approved restaurant site selection and regularly reviewed sales data. He held quarterly meetings with his partners and weekly telephone calls with the general manager to discuss the restaurants. He directed or negotiated payments to certain creditors to reduce GCAD debt, which he had personally guaranteed. He hired and fired upper-management employees. Although Erwin delegated many of GCAD's day-to-day financial responsibilities to others, he infused capital into GCAD and admonished the Light brothers, over whom he had significant control, to stay current with the company's tax obligations.
The Court rejected Erwin's defense that others in the company may have been just as, or even more, responsible for GCAD's failure to remit payroll taxes. Code Sec. 6672 imposes liability on all responsible persons, not just the most responsible person.
The Fourth Circuit also found that Erwin, by preferring GCAD's other creditors to IRS, had willfully failed to remit GCAD's payroll taxes for the fourth quarter of '98 and the first three quarters of '99. GCAD generated several million dollars in gross receipts after August '99 and paid rent and food vendors with those funds instead of paying IRS.
Following the lead of every other circuit to consider the question, the Fourth Circuit adopted the rule that when a responsible person learns that withholding taxes have gone unpaid in past quarters for which he was responsible, he has a duty to use all current and future unencumbered funds available to the corporation to pay those back taxes. Accordingly, as of August '99, Erwin had a duty to use all unencumbered funds to reduce GCAD's tax liability from the prior quarters.
Even assuming that Erwin did not act willfully prior to learning of the full extent of the tax deficiencies in August 99, his conduct after that point unquestionably evidenced willfulness as a matter of law. During the third quarter of '99, GCAD paid just a fraction of its payroll tax liability. Although Erwin and his business partner each made capital contributions to cover the deficiency in December of '99, GCAD still owed over $100,000 for that quarter alone and had not satisfied deficiencies from '98 and the first two quarters of '99. Erwin was on notice that GCAD owed substantial payroll taxes to IRS. Yet Erwin and his business partners continued to rely on the Light brothers to address the problem for several more months. His failure to assess and remedy the payroll tax deficiencies immediately on learning of them in August '99 constituted unreasonable willful conduct. The Court found that this was particularly so given that, at Erwin's direction, GCAD paid other creditors during this period. As a result, the Court held that Erwin was liable for any outstanding third-quarter '99 deficiencies.