Failure to Pay Over Payroll Taxes Could Land You in Jail

September 25, 2008

Failure to pay over withheld payroll taxes may get you a new roommate — in jail. In United States v. Easterday, No. 07-10347, 2008 U.S. App. LEXIS 18013 (9th Cir. August 22, 2008), the United States Court of Appeals for the 9th Circuit affirmed a conviction and 30-month sentence for Mr. Easterday’s failure to pay over withheld payroll taxes to the Internal Revenue Service (IRS).

Employers are required to withhold from an employee’s wages income taxes (Federal and State) and the employee’s share of FICA (Federal Insurance Contributions Act) taxes. The Internal Revenue Code makes the employer a fiduciary of the United States with respect to these withheld taxes. When an employee’s income taxes and share of FICA taxes are withheld from the employee’s wages by the employer, the employee is treated as having paid those amounts to the IRS, whether the employer actually pays over such amounts to the IRS. This protects employees if the employer never pays over such amounts.

Employers experiencing cash flow problems sometimes fail to pay over the withheld taxes, choosing instead to use the cash attributable to those taxes to fund operations. BIG MISTAKE. If an employer’s business ultimately fails and can not pay the IRS the withheld taxes, the IRS will seek to collect them from any “responsible person” of the employer (e.g., an officer, director, shareholder (or other owner), or bookkeeper with signature authority over a bank account). This personal liability for the “responsible person” can be substantial. Moreover, in rare cases the IRS may seek criminal prosecution.

Mr. Easterday was the principal of a corporation that operated a number of nursing homes throughout Northern California. Between 1998 and 2005, the corporation and its subsidiaries accumulated a nearly $45,000 payroll tax liability, approximately $25,000 of which was paid. The corporations’ tax returns accurately stated their tax liability, but the corporations failed to pay over the actual taxes to the IRS. Mr. Easterday admitted that the companies in question had failed to pay over their payroll taxes, but claimed that he and his companies lacked the financial capacity to meet their tax obligations.

In response to the companies’ and Mr. Easterday’s failure to pay over their payroll taxes, the IRS charged Mr. Easterday with 109 counts of failure to pay over payroll taxes in violation of Section 7202 of the Internal Revenue Code. Each count represented a different quarter in which the payroll taxes went unpaid. At trial, Mr. Easterday’s witnesses testified that the companies’ did not pay their payroll taxes because those funds were needed to keep the nursing homes at issue operational. In light of this testimony, Mr. Easterday asked the court to instruct the jury that it had to find that his violation of Section 7202 had not been willful if the jury found that he lacked the ability to pay the payroll taxes due to the IRS. The trial court declined to give requested instruction, and the jury convicted Mr. Easterday.

On appeal, the Ninth Circuit affirmed the decision not to provide the jury instruction Mr. Easterday requested. The Court held that, although the statute requires a person to willfully violate the statute to be guilty of a Section 7202 offense, willfulness does not require the defendant to have the ability to pay the payroll taxes in question. Instead, the Court concluded that the willfulness required by Section 7202 merely constitutes a knowing and voluntary violation of one’s obligation to pay over payroll taxes to the IRS. In addition, the Court noted that Mr. Easterday’s position did not make sense when he could simply escape liability for paying over funds owed to the Government by claiming that they had been spent on something else. Thus, the Court recognized that the payroll taxes in question were the property of the United States and were simply being held in trust by Mr. Easterday until such time as they were to be disbursed to the IRS.