Personal liability for your company’s taxes, even if you work for a nonprofit

Serving on the board of directors of a nonprofit can be rewarding, but not if you end up paying for the organization's tax problems. Your first reaction might be to say, "what tax problems; after all, aren't nonprofits, especially public charities, tax exempt?" Not entirely. For example, nonprofits that have employees still have to pay payroll taxes.

Even more than most other taxes, the IRS takes payroll tax liabilities deadly seriously. As with any employer, if the charity doesn't pay, the IRS has the ability to go after individual officers, directors or check signers who could have done something about it. So, regardless of what kind of company you work for, don't sign checks and expect to avoid liability if the IRS comes along. Even the U.S. Supreme Court may turn a deaf ear. In one well-known case, it let stand a whopping $11 million in IRS penalties. See Davis v. United States, 495 U.S. 472 (1990).

For any company or organization with employees, paying employment taxes is inevitable. You withhold taxes from employee pay, and send the money to the IRS. When the taxes are withheld from wages, they are supposed to be promptly paid to the government. This is trust fund money that belongs to the government. No matter how good a reason the employer may have for using the money for something else, the IRS is strict.

It can be tempting to think that you have to keep the rent paid and the supplies ordered to keep the organization running. You might figure that the IRS won't miss the payroll tax money if you divert it just temporarily. But you never want to become delinquent, and problems can sometimes snowball. If you are labeled a responsible person, it means the IRS can pursue you personally if the company fails to pay. The IRS calls it a Trust Fund Recovery Assessment, also known as a 100% penalty, and they can assess it against every responsible person.

The IRS does this quite regularly, and has a well-oiled system down, starting with Section 6672(a) of the tax code. Anyone with employees is expected to know that tax withholding must be taken and the money must be promptly sent to the IRS. You can be liable even if you have no knowledge the IRS is not being paid.

The IRS tends to be unforgiving, so the taxes, penalties and interest can add up quickly. Charities and other nonprofit organizations with employees have to pay payroll taxes too, and even if you're an unpaid volunteer, you can be stuck with personal liability. Take the case of Anthony Cuda, United States v. Cuda and Dankis, Civil Action No. 10-617 (W.D. Pa. Oct. 4, 2011). Mr. Cuda was the operations director of Seneca Area Emergency Services, Inc. (SAES), a nonprofit providing ambulance and emergency medical services.

It turned out that the office manager was embezzling and stopped paying bills -- including the IRS. Poor old Mr. Cuda was responsible for overseeing day-to-day operations, had authority to sign checks and to provide input on prioritizing SAES's bill payments. The IRS located Cuda and told him to pay up. Cuda tried everything to get out of it, arguing that:

1. He didn't know the taxes weren't being paid;

2. SAES was going bankrupt, and actually did file for bankruptcy protection; and

3. It was the CFO who should have collected and paid the taxes, not Cuda.

But the court rejected all of these arguments. The court said it wasn't in the business of assigning comparative fault. Each responsible person was 100% liable. Since Cuda was the one in court at the moment, he had to pay. When there are multiple officers, directors or signers whom the IRS is chasing, each responsible person in the IRS's cross-hairs tries to make sure that someone else pays before they have to. Since the penalty is 100% of the taxes, the IRS can collect it only once.

When multiple owners and signatories all face tax bills, they generally do their best to direct the IRS to someone else. Small factual nuances matter in this kind of mud-wrestling, but so do legal maneuvering and just plain savvy. One responsible person may get stuck, while another may pay nothing. Meanwhile, the government will still try to collect the taxes from the company that withheld on the wages. And those IRS collection efforts can be serious.

The IRS can move to collect via a levy on your bank accounts. But before a levy can be issued, the IRS must provide notice and an opportunity for an administrative Collection Due Process hearing. A Collection Due Process hearing is only available for certain serious IRS collection notices. Among other things, it allows you the opportunity to ask for an installment agreement, an offer in compromise or another collection alternative.

There are special rules in the case of what the IRS calls predecessor employers. Some procedural safeguards won't apply if you are a predecessor employer. Here's what the IRS evaluates to determine if one business is a predecessor of another:

Does it have substantially the same owners and officers? Are the same individuals actively involved in running the business, regardless of whether they are officially listed as the owners/shareholders/officers? If the taxpayer's owners or shareholders are different, is there evidence they acquired the business in an arm's-length transaction for fair market value?

Does the business provide substantially the same products, services, or functions as the prior business? Does the business have substantially the same customers as the prior business? Does the business have substantially the same assets as the prior business? Does the business have the same location/telephone number/fax number, etc. as the prior business? See IRC Section 6330(h).

A business won't be treated as a predecessor if there was a genuine change in control and ownership, as where the business was acquired in an arm's-length transaction for fair market value, where the previous owners have ceased all involvement. The IRS's guidance lists examples of predecessor status and explains how to determine if a business requesting a Collection Due Process hearing for employment taxes is a "predecessor." There's no right to a Collection Due Process hearing to resolve the employment tax liabilities if you already had your chance.

All these rules are pointing one direction. Regardless of what kind of employer is short on payroll taxes, and regardless of your role there, be careful. The stakes can be high, and so can the cost of missteps. 