Does Failure to Oversee A Trusted Employee Equal Willful Conduct for the Trust Fund Recovery Penalty?

In prior blog posts (here) and (here) we discussed the McClendon case where a doctor made a loan to his business to make payroll, and in doing so, inadvertently exposed himself to liability for the trust fund recovery penalty.    The 5^th Circuit recently returned the case to the U.S. District Court for further consideration, including the Government’s argument that the doctor’s failure to oversee the trusted employee to whom he delegated the duty of filing payroll tax returns and paying the employment taxes satisfies the willfulness element of IRC Section 6672.

Blog readers will recall that Dr. McClendon was the founder of a family medical practice that had employed numerous doctors, nurses and staff.   By 1994, the practice had grown large enough to hire a CFO/CPA, Richard Stephen, to manage the practice.  Mr. Stephen regularly reported to Dr. McClendon and other board members that the association was doing well financially and that its tax obligations were being met.  In reality, Mr. Stephen was embezzling millions of dollars and left the practice with an unpaid federal employment tax liability totaling $10 million for the years 2003-2008.  Mr. Stephen was subsequently convicted of felony theft and sentenced to ten years imprisonment.  The IRS assessed the trust fund penalty against Dr. McClendon for the years 2003-2008 which the doctor disputed in U.S. District Court.

In its motion for summary judgement, which the District Court will be reconsidering, the Government argued that:

McClendon was also, at best, grossly negligent in delegating to Stephen the responsibility of paying payroll taxes for years with absolutely no oversight of what Stephen was actually doing. Even after being warned in 2007 and early 2009 that is was extremely risky to rely so heavily on one unsupervised person, McClendon took no action until confronted with the fact that [the business] had millions of dollars of unpaid withholding taxes. McClendon is clearly willful under Section 6672 as a matter of law.

In response to this argument a concurring opinion in the 5^th Circuit notes:

I don’t see how, under the circumstances before us, the district court could rule on now-deceased Dr. McClendon’s “reckless” disregard of his tax duties as a matter of law. Given that he and his partners employed Stephen for a decade before the CPA started embezzling, their reliance on his handling of their business affairs seems at least plausible.

It will be interesting to see how the District Court, and likely the 5^th Circuit, resolve this issue.  In the meantime, tax professionals would be wise to advise their business-owner clients who delegate payroll tax duties to confirm that payroll tax returns are being filed and employment taxes are being paid.

For any questions on this or any other tax-related matter, please feel free to contact me at (214) 749-2456 or jcrouch@meadowscollier.com.