Few officers and directors realize that the Internal Revenue Service (IRS) may hold them responsible for certain taxes owed by their employees.  Under the Internal Revenue Code (IRC), employees are allowed a credit against their tax liability for the amount withheld from their wages, regardless of whether the employer actually remits the funds to the government.  Thus, when net wages are paid to an employee, the taxes that were or should have been withheld are credited to the employee, and the IRS has no recourse against the employee for their payment.  In many circumstances, § 6672 of the IRC makes the person responsible for remitting the taxes withheld from the employees’ wages to the IRS liable for payment of such taxes.

Taxes withheld by an employer, commonly referred to as "trust fund” taxes, constitute a trust in favor of the IRS from the time that the employer deducts them from the employee's gross wages.  Section 6672 subjects all persons considered responsible for the withholding and payment of trust fund taxes to a penalty equal to the amount of the taxes due where the employer fails to turn over such funds to the government.  Thus, the IRS can look beyond the corporate form and hold certain agents and officers of the corporation personally liable for taxes withheld from the employee’s wages that were not paid to the government.  The penalty under § 6672 is commonly referred to as the "100% penalty" because any responsible person is liable for 100% of the unpaid trust fund taxes. 

Liability under § 6672 attaches to an individual who is responsible for collecting, truthfully accounting for, and paying over any tax imposed under the IRC.  Generally, the determination of whether the requisite responsibility exists is a question of the individual's status, duty, and authority in the business which has failed to collect, truthfully account for, and pay over federal withholding taxes. This determination is considered in the context of the person's authority over a company's finances or general decision making.  In addition, the liability under   § 6672 will only attach to a person who acts “willfully” in failing to pay over the trust fund taxes.  Willfulness is defined as an intentional violation of a known legal duty.  For example, evidence that a chief financial officer knew that “trust fund taxes” were being used to pay a supplier instead of the IRS is an indication of willfulness.  More than one individual may be a responsible person with respect to the same company, with all responsible individuals being jointly and severally liable for the penalty.

The primary focus of § 6672 has traditionally been on income taxes and social security taxes that must withheld by an employer from the gross wages paid to employees.  The scope of the statute, however, extends to all taxes imposed under the IRC where there is a corresponding withholding or collection obligation.  Accordingly, § 6672 applies to taxes that must be withheld or collected on transactions such as payments of gambling winnings, interest and dividend payments subject to backup withholding.  Section 6672 does not apply to direct tax obligations imposed on an employer such as the employer's portion of social security tax or unpaid corporate income taxes.

The IRS has also used § 6672 to impose a penalty on an employer who misclassifies workers as independent contractors instead of employees.  This penalty would only apply in situations where the responsible person had knowledge of the misclassification or where the responsible person did not reasonably believed that the classification was proper.  However, § 6672 would not apply when the employer can prove there was a reasonable basis for not treating workers as employees or that there was no intentional disregard of the withholding rules.

Finally, § 7202 of the IRC renders the willful failure to collect or pay over trust fund taxes a felony, and allows the government to impose criminal penalties to ensure that employers comply with the obligation to truthfully account for and pay to the government the sums withheld.  Although rarely invoked, § 7202 provides that upon conviction of this felony, the defendant may be fined or imprisoned not more than five years (or both), and made to pay the costs of prosecut