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Trust fund penalty responsible person for the Code Sec. 6672(a)

Tax-exempt hospital’s chairman of the board was liable for trust fund penalty have a tax professional on your side

Mike Habib, EA


Stephen Verret v. U.S. (DC TX 2/14/2008) 101 AFTR 2d ¶2008-572

A district court has found that the chairman of the board of a tax-exempt hospital was a responsible person liable for the Code Sec. 6672(a) trust fund penalty. The chairman, who played an active role in various aspects of the hospital’s operation and could have ensured that the hospital paid its taxes, chose instead not to exert any authority over these business affairs. Further, since the chairman wasn’t serving solely in an honorary capacity, he didn’t qualify for the protection given voluntary board members under Code Sec. 6672(e).

    Observation: The case once again demonstrates the perils faced by a taxpayer who becomes involved in a financially distressed company. As this case illustrates, the fact that a company is a tax-exempt entity will not shield a taxpayer who fails to carefully exercise his duties to make sure employment taxes are paid to IRS.

Background. Where an employer fails to properly pay over its payroll taxes, IRS can seek to collect a penalty equal to 100% of the unpaid taxes from a “responsible person,” i.e., a person who: (1) is responsible for collecting, accounting for and paying over payroll taxes and (2) willfully fails to perform this responsibility. (Code Sec. 6672(a))

Unpaid volunteer board members of tax-exempt organizations who are solely serving in an honorary capacity, aren’t involved in day-to-day financial activities, and don’t know about the penalized failure are exempt from the penalty, unless that results in no one being liable for it. (Code Sec. 6672(e))

Facts. The primary business of Community Healthcare Foundation (Foundation), a Code Sec. 501(c)(3) tax-exempt organization, was the operation of Doctors Hospital. Under the hospital’s by-laws, the Foundation provided that the Board of Trustees, which was comprised of voluntary and unpaid members of the community, would act as the governing body of the hospital. The by-laws also provided for a Chairman of the Board and a Chief Administrative Executive Officer (CEO).

Stephen Verret served in various capacities on the hospital’s board during a 26-year tenure, including as Chairman of the Board from ’99 until his departure in 2002. In addition, a company in which Verret was a majority stockholder performed electrical services for the hospital, and his wife was employed by the hospital as Chief Operating Officer from January through March 2001. Verret also contracted with, and was paid by, a business involved in the operation and management of hospitals to help recruit specialized physicians and increase the hospital’s revenues.

Because of a steadily deteriorating financial situation, the hospital failed to remit employment withholding taxes during the first part of 2001. While the outstanding tax liability was ultimately satisfied with borrowed cash appropriated to buy medical equipment, the hospital’s Executive Director David Cottey was informed by Verret, individually, and by the Board, collectively, that the payment of employment withholding taxes was of paramount importance. Under no circumstances, he was told, was he to fail to pay these taxes again. However, contrary to his repeated assurances throughout 2001, in November of 2001, Cottey told Verret and the Board that the income and FICA taxes for the employees were delinquent for the third and fourth quarters of 2001.

IRS found Verret and the hospital’s Controller and Chief Financial Officer to be liable as responsible persons. Verret paid $407,098 in tax (and $1,821 in interest), and sought a refund in the district court. IRS responded by seeking a summary judgment against Verret.

Taxpayer is responsible person. The district court concluded that Verret clearly qualified as a responsible person under Code Sec. 6672. The court rejected his contention that he wasn’t responsible for the hospital’s day-to-day operations and that he didn’t have the authority to decide what bills (including taxes) were paid. The by-laws clearly stated that the Board of Trustees had the final responsibility for the hospital’s administrative activities and professional services and for the operation of the hospital. The uncontested facts showed that Verret: (1) served approximately 26 years in various capacities on the hospital’s Board; (2) held the position of Board Chairman during the relevant periods; (3) negotiated and personally guaranteed a $500,000 working capital loan for the hospital; (5) took steps to ensure payment of delinquent withholding taxes on the previous occasion after Cottey had failed to do so; (6) actively participated in recruiting physicians and developing a new source of revenue for the hospital; (7) conversed with Cottey on almost a daily basis; (8) signed the hospital’s Form 990 for ’99 and 2000; (9) possessed, along with the Board, the authority to hire and fire high level employees; and (10) was a signatory on all of the hospital’s checking accounts.

The district court also concluded that his failure to pay taxes was willful. The court reasoned that it was inconceivable that Verret, who spent significant amounts of time visiting the hospital and conversing with Cottey on a daily basis, was unaware of Cottey’s failure to pay the employment taxes. If Verret didn’t know of Cottey’s failure to pay the tax liability during the third and fourth quarters of 2001, it was because he chose not to know. Verret could have exercised substantial control over the decision-making process to ensure that the hospital paid its taxes, but instead of verifying that the taxes were paid, he chose not to exert authority over Cottey or the hospital’s business affairs. The court reasoned that this inaction, at a minimum, constituted gross negligence or reckless disregard and so a willful failure to collect, account for, or pay over the hospital’s taxes.

The court also found that Verret didn’t qualify for the protection afforded a voluntary board member under Code Sec. 6672(e). He wasn’t serving solely in an honorary capacity as the Chairman of the Board. Rather, he played an active role in the management of the hospital, attending board meetings, negotiating and guaranteeing a loan, recruiting physicians, and signing the hospital’s Form 990 for ’99 and 2000.

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