Shareholder Agreements, Buy-Sell Agreements, Partnership and Operating Agreements (collectively, “Agreements”) are frequently-used terms to describe agreements among business owners. Hopefully, the Agreement, whatever its title, covers issues such as contributions of property and services, management, voting, dispute resolution, and ownership transition.
One of the uglier issues facing business owners is the personal liability for the trust fund portion of payroll taxes withheld from employee wages. As anyone who has been employed knows, an employer is obligated to withhold payroll taxes from the wages of an employee. This withholding is known as the Trust Fund Portion and is in addition to the payroll tax the employer must pay from its own funds. When the Trust Fund Portion is not paid over to the government, the tax collector invokes the responsible person doctrine. In its elementary form, the doctrine imposes personal liability upon owners, officers and managers for payment. The doctrine extends its reach to those individuals who have the ability to direct the payment of funds. While this blog does not attempt to analyze years of case law, a rule of thumb is that check signing authority makes an individual a responsible person. A caveat to that rule is that anyone who exerts direct or indirect control over who the business pays will also be considered as a responsible person. Many cases exist where one who is essentially a bookkeeper with check signing authority is controlled by an owner who does not have check signing authority in an effort to protect the owner from liability. As the owner typically has more money, they become a natural target of the tax collector.
United States v Commander
In United States v Commander, the Third Circuit Court of Appeals upheld a District Court decision holding Mr. Commander liable for unpaid payroll taxes of 1.5m. What is interesting is that Mr. Skerianz, the equal partner, was dismissed during the pendency of the case after he died. We do not know whether a settlement was reached between the decedent’s estate and the government. But we do know that Mr. Commander was not relieved of responsibility for the entire liability which is not apportioned in accordance with ownership.
Agreements typically have buy-sell provisions that are triggered at death and often use life insurance to fund the buy-out. Recently, I discussed a situation with a prospective client where the life insurance policies obtained on the lives of two equal partners were intended to be paid to a third party acting as trustee and be used to extinguish the decedent’s half of the liability. Unfortunately, each spouse was designated as the beneficiary for the policy on the life of his or her owner-spouse. When the life insurance proceeds arrived made payable to a surviving spouse, who was not a responsible person, it was not hard to anticipate that the surviving spouse held onto the funds. Although the government has weapons it can use against the estate and transferees, it is easier to chase the living than the dead.
One avenue open to the surviving partner is to file suit against the surviving spouse in Chancery court claiming a constructive trust over the proceeds. This would, if successful, give effect to the arrangement that was contemplated. Proving what was intended, however, is often difficult.
The facts described in the two preceding paragraphs raise questions about the purpose and use of life insurance proceeds. Clearly, the value of the business is negligible if not negative; therefore, the notion of a buy-sell under these conditions is inappropriate. Should the proceeds be applied to extinguish the tax debt? Would such application give the surviving owner a debt-free business and leave the estate hoping for payout? What would be the value of the business if the debt is not paid? Is it the value before death burdened by tax debt or is it a value determined well after death, insurance money received and the debt is repaid?
What should be discussed is how the proceeds of life insurance should be applied and whether some, all or none should be applied to the tax debt. If half of the proceeds were applied to the tax debt, there is no automatic release for the estate form the liability for the entire debt unless IRS agrees. When businesses and owners encounter Trust Fund liability, seldom are Agreements revised to address these new problems.
If you have questions, please contact us
Do you have any questions? Would you like to discuss the matter further? If so, please contact me, James McDonough, or the Scarinci Hollenbeck attorney with whom you work at 201-806-3364.