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Receivers Pay Personally for Ignoring the IRS Payroll Tax Priority By Rosen, Charles* Let’s talk about potential payroll tax problems. The following questions
should interest receivers since receivers may become personally liable to
Uncle Sam for unpaid pre-receivership payroll taxes and / or payroll taxes
they incur during administration that are not paid. Even more chilling,
the receiver may not be able to use the appointing court or its authority
for a qualified immunity defense. A: The rule in Federal court receiverships is simple. Under Judicial Code § 980(a) [Title 28 U.S.C. § 960] “Any officers and agents conducting any business under authority of a United States court shall be subject to all Federal, State and local taxes applicable to such business to the same extent as if it were conducted by an individual or corporation.” [And don’t think a receiver can escape the rule if the defendant is a partnership, LLC or the like.] The payment may not even be deferred until some time later in the case, when assets have been liquidated and additional funds become available to pay the receivership’s taxes and other expenses. This has long been the rule, but was often ignored by bankruptcy trustees and receivers. It has been strengthened by additional language in the recently enacted Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which states that “(b) A tax under subsection (a) shall be paid on or before the due date of the tax under applicable nonbankruptcy law . . .” Note that it says the due date of the tax, not the due date of the tax return. Thus if a Federal Tax Deposit or electronic deposit is required to be paid shortly after the payroll was paid, the funds are to be paid to the IRS or the EDD by the normal due date for the payment, not later, when the return is required to be filed. It may be argued that this rule only relates to federal court cases (since the language is in the U.S. Judicial Code), but ignoring federal taxes does not make for good state court receivership practice either. Federal tax law is not bound by state law or state court rules or state court procedures. The sovereign is not bound by the state. Q: Are unpaid payroll taxes and/or unpaid income taxes a priority over other trade creditors in making a distribution in a receivership? A: One of the oldest laws of the United States is commonly called The Insolvency Statute. It was first enacted on July 31, 1789 [1 Stat. 29], and has its roots deep in English common law. While it has been moved from time-to-time, codified and then moved again, it has basically remained unchanged. It is presently located at Title 31 U.S.C. § 3713, and states in pertinent part,
Elsewhere in the code “person” is defined to include corporations and partnerships and likely also would be interpreted to include LLCs, LLPs and other legal entities. Therefore a receiver who pays another creditor before paying any federal government claim - tax or otherwise - may become personally liable for the amount paid to a third party if the U.S. debt has not first been paid in full. There is a limited exception — case law has established that a receiver is permitted to pay costs ahead of the government’s claim without incurring such personal liability (see, Kennebec Box v. O.S. Richards Corp., 5 F.2d 951 (2nd Cir. 1925)). “Costs” are defined as costs of preserving or selling assets, or using funds to generate additional assets in the estate. The receiver’s fees and administrative costs are also allowed to be paid first. Today’s rule for the wise: pay the federal government before paying any non-administrative expenses or fees. Q: A receiver discovers that several individuals who are employed at a company are treated as “independent contractors” [ICs]. The receiver believes these individuals better fit the definition of an employee rather than an IC. Because the company paid them as ICs prior to the receiver’s appointment, may the receiver continue this practice, or must the receiver change the procedure? A: IRS Publication 15-A, Employer’s Supplemental Tax Guide, has a detailed discussion of what constitutes a statutory employee, a common law employee and an independent contractor. In determining how a receiver should treat such a person, the receiver should carefully read this publication, which is available on the IRS web site at www.irs.gov. If an informed receiver determines that a person previously treated as an IC is actually properly classified an employee, appropriate withholding taxes should be deducted from wages paid to this person in the future. Failure to do so as determined by a later IRS payroll tax audit could result in a deficiency that is chargeable to the receivership estate. Though unlikely, it is not impossible that the receiver responsible for not withholding payroll taxes would be held personally liable for the tax under another provision of the Internal Revenue Code. The best advice is for the receiver to convert the IC to employee status and withhold and pay appropriate payroll taxes. It is also true that (a) if a claim is filed against a receivership by a person who was inaccurately classified as an IC, (b) the claim is being paid by the receiver, and (c) the receiver therefore knows the person should have been paid as an employee, the receiver is obligated to withhold taxes from sums paid to this person, report the tax on a payroll tax return and pay the tax over to the government. The receiver should also issue a W-2 form to the person. Q: The receiver shuts down a company, and wishes to retain one of the former accounting department employees to assist in the collection of accounts receivable. May the receiver re-hire this person as an IC, or must the receiver retain the individual (who will be doing essentially the same job as before the closure) as an employee if that definition seems most applicable? A: Depends. Again, look to IRS Publication 15-A to determine the proper status for this person. Whether a person is an employee or IC is based on the facts in each case. Generally, an individual is an IC if the person for whom the services are performed has the right to control or direct only the result of the work and not the means and methods of accomplishing the result. A person is best defined as an employee when the employer has the right to control what will be done and how it will be done. This is even true when the employee is given freedom of action. What matters is that the employer has the right to control the details of how the services are performed. If the person fits the definition of an employee, appropriate taxes
should be withheld and the receiver should either (a) secure a new Federal
Employer Identification Number for the receivership or (b) include this
person in the receiver’s own staff payroll. Either way, the tax should be
paid over to the government, reported on the proper payroll tax return,
and Form W-2 should be issued to the employee. |