Tag Archive for: irs

The IRS’s Trust Fund Recovery Penalty: A Perilous Trap for the Unwary

Under the Internal Revenue Code (the “IRC”), employers must withhold certain taxes from employee pay. These monies are referred to as “trust fund taxes” because they are held in trust on behalf of the government, and employers must turn these withheld amounts over to the government on a regular basis.

For various reasons, employers sometimes fail to remit these trust fund taxes to the government when they are supposed to. For example, struggling businesses facing challenging financial decisions as to which creditors will be paid to keep the business afloat, may fail to pay withheld taxes and instead “borrow” from the government to pay other creditors first. This may be a perilous path not only for the employer but also for individuals within the organization who have decision-making authority. While other creditors may have to rely on veil-piercing concepts to collect the company’s liability from anyone other than the company, the federal government does not.

To allow the IRS to collect, Congress authorized § 6672 of the IRC which allows IRS to collect directly from the personal assets of certain control individuals. As was stated in Wright v. United States, “[t]he statute is harsh, but the danger against which it is directed—that of failing to pay over money withheld from employees until it is too late, because the company has gone broke—is an acute one against which, perhaps, only harsh remedies are availing.” 809 F.2d 425, 428 (7th Cir. 1987).

In a nutshell, § 6672 provides that any person required to collect, account for, and pay any tax imposed under the IRC who willfully fails to do is liable for a penalty equal to the total amount of the unpaid tax. Thus, liability under § 6672 attaches if an individual both (i) qualifies as a “responsible person”; and (ii) “willfully” fails to pay over the amount due.

Section 6672 has been interpreted by the courts quite broadly to encourage individuals to stay abreast of their companies’ withholding and employment taxes. As such, the penalty has ensnared many an unsuspecting charitable board member, officer, bookkeeper, accountant, investor, or other person associated with a taxpaying organization. Thus, it is important for anyone in such a position to bear in mind that their title carries significant risk. Even where such a person is completely non-complicit in the discouraged activity, they may still bear the burden of mounting a legal defense against IRS claims.

It is also important to understand that each such responsible person is liable for 100% of the trust fund recovery penalty. Perhaps the only significant limitation on the IRS’s latitude is that, while it may assess any and all responsible persons until the amount due has been paid, it can collect the tax due only once. Also, IRS claims preempt state law, rendering for example, creditor protections for homestead real property inapplicable.

While the government bears the burden of proving that the taxpayer is a responsible person, taxpayers bear the burden of proving a failure was not willful. Willfulness has been defined as the “voluntary, conscious, and intentional decision to prefer other creditors over the United States.” Ruscitto v. United States, 629 Fed. Appx. 429, 430 (3d Cir. 2015).

Illustration by legal assistant Charles Jackson

The willfulness requirement is satisfied when the responsible person makes the deliberate choice to pay the withheld taxes to other creditors, instead of paying the government. Where the responsible person does not segregate the trust fund taxes but uses them to cover operating expenses (such as employees’ wages and claims of other creditors), each payment may be a voluntary, conscious, and intentional decision to prefer other creditors over the government. This requirement is satisfied with something as simple as making payroll. Thus, in most business scenarios, negating willfulness can present a significant challenge.  Importantly, § 6672 is a civil, and not a criminal, statute. Its criminal analogue, § 7202, requires the additional concept of “known legal duty” to comply with due process of law requirements under the Constitution. However, no such requirement is associated with § 6672, so it is much easier for the government to meet its burden of proof.

To sum up, it is absolutely critical for all control persons within any taxpaying organization (including nonprofits and government entities, which are nonetheless subject to withholding requirements and employment taxes) make themselves aware of applicable deadlines and other procedural requirements. Failure to do so can result in life-altering penalties being assessed against personal assets including homesteads and other property which is generally considered exempt from creditor claims. Could you write a personal check for 100% of your organization’s employment taxes?

If you have questions regarding the Trust Fund Recovery Penalty or are facing other IRS issues, please reach out to FGHW for a consultation.


Christian Kelso | Farrow-Gillespie & Heath LLP | Dallas, TX

Christian S. Kelso, Esq. is a partner at Farrow-Gillespie Heath Witter LLP.  He draws on both personal and professional experience when counseling clients on issues related to estate planning, wealth preservation and transfer, probate, tax, and transactional corporate law. He earned a J.D. and LL.M. in taxation from SMU Dedman School of Law.

Nonprofit Organization Lobbying

Can my Nonprofit Organization Conduct Lobbying Activities?

A Section 501(c)(3) taxexempt organization may conduct limited lobbying activities without jeopardizing the organization’s taxexempt status, so long as lobbying does not form a “substantial part” of the organization’s overall work.

An organization that intends to lobby and wants to be tax-exempt can apply either as a 501(c)(3) public charity or as a 501(c)(4) organization.  Although a Section 501(c)(4 ) organization is tax-exempt (i.e., the organization itself pays no taxes), donations to it are not tax-deductible to the donor.  So typically, the 501(c)(4) route is not as popular an option as organizing under Section 501(c)(3).

If the organization wants to lobby but does not intend for lobbying to be its primary activity, it may be possible to organize and file for tax-exempt status as a 501(c)(3) organization.  A 501(c)(3) organization is tax-exempt itself, and donations to it are tax-deductible to the donor.  Under Section 501(c)(3), an organization can do some lobbying – it just cannot devote a “substantial part” of the organization’s activities to lobbying.

Lobbying can be “direct” or “grassroots.”  Direct lobbying is defined as any communication with a legislator that expresses a view about specific legislation (or other matter on which the legislator may vote).  Grassroots lobbying is defined as any communication with the general public that (a) expresses a view about specific legislation (or a matter on which the legislature is voting) and (b) includes a call to action.

The IRS has two alternative tests for determining “substantial.”  One way is in terms of relative time spent on lobbying activities.  The other and probably best way to stay beneath the “substantial” threshold is to meet the “expenditure test.”  A complete table is below, but in general, an organization with an overall budget of less than $500K may spend only up to 20% of that budget on lobbying.  To use the expenditure test, the organization must file a form to elect to do so, and then the expenditure reporting must appear on the organization’s normal 990 annual reporting form.

 If the amount of exempt purpose expenditures is:  Lobbying nontaxable amount is:
 ≤ $500,000  20% of the exempt purpose expenditures
 >$500,00 but ≤ $1,000,000  $100,000 plus 15% of the excess of exempt purpose expenditures over $500,000
 > $1,000,000 but ≤ $1,500,000  $175,000 plus 10% of the excess of exempt purpose expenditures over $1,000,000
 >$1,500,000 but ≤ $17,000,000  $225,000 plus 5% of the exempt purpose expenditures over $1,500,000
 >$17,000,000  $1,000,000

Certain gray-area activities have been held to be “non-lobbying advocacy” as opposed to “lobbying.”  These advocacy activities can be unlimited and do not count against the lobbying expenditure test.  Examples are educating policymakers and the public about broad social issues, encouraging people to register to vote, organizing communities, educating voters about candidate positions, litigating, conducting educational meetings, preparing and distributing educational materials, considering public policy issues in an educational manner, and other activities.

If a 501c3 organization goes over the line and devotes a “substantial” part of its activities to lobbying, then the penalties are severe. Tax-exempt status is retroactively lost; deductibility of donations is retroactively lost; a 5% excise tax may apply; and a very large penalty (usually 25%) applies to the tax that will be due.  Hence, close monitoring of lobbying activities is an absolute necessity.

A political activity in which a 501(c)(3) organization may never engage is to support or oppose any candidate for public office.  This prohibition is absolute.

All organizations that conduct lobbying are subject to reporting and disclosure rules at the state and local level.

For more information about nonprofit organizations, or to find out about our fixed fees for formation of charitable organizations and family foundations, please contact us.

Angela Hunt Assists Aldredge House to Keep Doors OPen

Forming a 501c3: The “Texas Three-Step”

Individuals and families may establish a 501c3 tax-exempt charitable organization to accomplish substantive philanthropy while receiving very favorable tax treatment. The degree of maintenance such an organization requires depends whether the organization can be classified as a public charity or is instead a private or family foundation.

Either way, forming a 501c3 is a three-step process.

Step One: Form the Organization

A charitable organization must be formed as a corporation in the state in which it is to be located. Many states, including Texas, have a special corporate form called a “nonprofit corporation,” which the organization is required to use be able to qualify for tax-exempt status. Special provisions must be included in the Articles of Formation.

Formation of a nonprofit corporation in Texas is less expensive than formation of a business corporation. To register the entity with the state, the filing fee is only $25.

Step Two: Obtain Federal Tax-Exempt Status from the IRS

Formation as a nonprofit organization does not automatically make the organization tax-exempt. For the organization’s income to be tax-free, and for donations to be tax-deductible to the donor, another step must occur. The organization must file for tax-exempt status with the IRS.  The application for tax-exempt status (Form 1023) is a comprehensive application for which legal assistance is usually desired. Small organizations may qualify for the new, simpler application (Form 2012-EZ) that was introduced in 2014. Most organizations with anticipated annual gross receipts of $50,000 or less and assets of $250,000 or less are eligible for the shorter application.

Step Three: Obtain State Tax-Exempt Status from the State of Formation

After an organization receives its tax-exemption letter from the IRS, a final step remains. The state in which the organization was incorporated must be notified of the IRS tax-exempt status. Most states, including Texas, have a streamlined process for obtaining state tax-exempt status once the IRS has approved federal tax-exempt status.

For a consultation on forming or administering a nonprofit organization or charitable foundation, contact us at (214) 361-5600 or email info@fghwlaw.com

Liza Farrow-GIllespie | Farrow-GIllespie & Heath LLP | Dallas, TX

New Simpler 501c3 Application for Small Charities

In July 2014, the Internal Revenue Service introduced a new, shorter application form to help small charities apply for 501(c)(3) tax-exempt status more easily.

The new Form 1023-EZ is three pages long, compared with the standard 26-page Form 1023. Most small organizations, including as many as 70 percent of all applicants, qualify to use the new streamlined form. Most organizations with gross receipts of $50,000 or less and assets of $250,000 or less are eligible.

Previously, all groups — regardless of size — went through the same lengthy application process regardless of size. This process created long delays for all organizations seeking to receive tax-exempt status.

According to the IRS: “The change will allow the IRS to speed the approval process for smaller groups and free up resources to review applications from larger, more complex organizations while reducing the application backlog. Currently, the IRS has more than 60,000 501(c)(3) applications in its backlog, with many of them pending for nine months. . . . We believe that many small organizations will be able to complete this form without creating major compliance risks.”

A reduced fee accompanies the streamlined application.  Whereas larger groups required to use the standard Form 1023 must pay a filing fee of $850, smaller groups entitled to use Form 1023-EZ must pay only $400. For either application, the fee is due at the time application is made.

For more information on charitable organizations, call us at 214-361-5600 or contact info@fghwlaw.com.