“Life” Goes On

In light of all the attention given to the reams of regulations recently proposed under the Tax Cuts and Jobs Act (“TCJA”), some people may be joking that tax advisers must have stopped counseling clients on more “mundane” business matters in order to dedicate themselves to the new rules. If these jokesters only realized how lengthy and convoluted these new rules actually are, they would quickly recognize that this was no laughing matter.

That being said, allow me to assure you that we have not suspended our efforts on behalf of our clients. Speaking for myself, I continue to see a steady flow, and a wide variety, of business-related tax issues that have no connection to the TCJA or its regulations, including a number that involve that bane of so many failing businesses: the failure to pay employment taxes – which is why the decision described below caught my attention.

“I Trusted You”

The IRS notified LLC that it had failed to pay employment taxes for the three preceding tax years. Shortly thereafter, LLC remitted payment for the unpaid taxes, along with the penalties and interest accrued thereon.

LLC then conducted an internal investigation into the matter, and found that its operations manager during the relevant time period (“Manager”) had failed to pay LLC’s taxes. Manager’s duties included ensuring that LLC filed its tax returns and paid its employment taxes. Unfortunately, Manager proved to be untrustworthy – they missed filing deadlines and did not inform LLC’s owner of the numerous IRS delinquency notices received. In addition, Manager began settlement negotiations with the IRS without LLC’s knowledge, let alone its approval.

The Refund Claim

After discovering the cause of its delinquent taxes, LLC sought a refund of the penalties and related interest it had paid.

LLC claimed that these penalties and interest should be abated because it had reasonable cause for its late payment of the taxes, citing Manager’s actions. LLC also claimed that its outside CPA had assured it that LLC had paid its taxes in a timely manner. The CPA, however, did not verify that the taxes were actually paid, but instead relied on Manager’s representations that they were paid.

The IRS denied the refund claim, and LLC subsequently filed a suit against the IRS, in Federal district court, to compel the sought-after refund. LLC argued that Manager’s “profound misconduct,” coupled with the concealment of that wrongdoing, prevented LLC from discovering the delinquency and timely fulfilling its tax obligations.[I]

The IRS filed a motion to dismiss, arguing that LLC had failed to establish the requisite reasonable cause. The IRS argued that a taxpayer’s duty to file its returns and pay its employment taxes was non-delegable and, therefore, could not be excused by an agent’s (i.e., Manager’s) misconduct.

The district court dismissed LLC’s case, and ruled in favor of the IRS. The court held that “[LLC] had an obligation to timely remit employment taxes. [LLC’s] reliance on its agents—an employee and an outside CPA—cannot constitute reasonable cause for its failure to remit those taxes.” LLC appealed to the U.S. Court of Appeals for the Eighth Circuit.

The Courts of Appeals

Once again, LLC argued that its failures to file timely tax returns and timely pay its employment taxes were excusable, relying on Manager’s malfeasance.[ii]

The Court disagreed, stating that “[t]he facts, whether considered singularly or together, do not excuse [LLC’s] tax law compliance failures” and did “not support a finding of reasonable cause.”

Reasonable Cause

The Court explained that the Code imposes penalties on those who fail to timely pay certain federal taxes, including employment taxes. An employer is required to withhold these taxes, place them into a trust fund, and report on a quarterly basis. Failure to do so subjects the taxpayer to penalties. “To escape the penalties,” the Court continued, “the taxpayer bears the heavy burden of proving both (1) that the failure did not result from willful neglect, and (2) that the failure was due to reasonable cause.”

Though the terms “willful neglect” and “reasonable cause” are not defined by the Code, an IRS regulation provides:

[i]f the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time, then the delay is due to a reasonable cause. A failure to pay will be considered to be due to reasonable cause to the extent that the taxpayer has made a satisfactory showing that he exercised ordinary business care and prudence in providing for payment of his tax liability and was nevertheless . . . unable to pay the tax . . . .

Self-Assessment and Delegation

The Court reviewed a number of decisions that recognized the importance of deadlines to the administration of the tax system, and which held that the payment of taxes was a non-delegable duty, and that an agent’s failure to act as expected did not absolve the principal of that duty.

The IRS has millions of taxpayers to monitor, the Court observed, and our system of self-assessment, in the initial calculation of a tax, “cannot work on any basis other than one of strict filing deadlines and standards.” Similarly, the prompt payment of taxes “is imperative to the government, which should not have to assume the burden of unnecessary ad hoc determinations.”

According to the Court, “Congress intended to place upon the taxpayer an obligation to ascertain the statutory filing and payment deadlines and then to meet those deadlines, except in a very narrow range of situations.”

When a taxpayer seeks the advice of a professional, the Court stated, the taxpayer may demonstrate an exercise of the “ordinary business care and prudence” prescribed by the regulations, “but that does not provide an answer to the question we face here.” To say that it was “reasonable” for the taxpayer to assume that the professional would comply with the statute may resolve the matter as between them, but not with respect to the taxpayer’s obligations under the Code. Congress has charged the taxpayer with “an unambiguous, precisely defined duty” to file a return and to pay the tax by a certain date. That a professional, as the taxpayer’s agent, was expected to attend to the matter does not relieve the principal of their duty to comply with the Code.

Technical Advice?

In so holding, the Court clearly distinguished between a taxpayer’s relying on an agent for professional legal advice and the taxpayer’s relying on an agent for non-technical, non-specialized matters:

When an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on that advice. Most taxpayers are not competent to discern error in the substantive advice of an accountant or attorney. To require the taxpayer to challenge the attorney, to seek a “second opinion,” or to try to monitor counsel on the provisions of the Code himself would nullify the very purpose of seeking the advice of a presumed expert in the first place. “Ordinary business care and prudence” do not demand such actions.

By contrast, one does not have to be a tax expert to know that tax returns have fixed filing dates and that taxes must be paid when they are due. Reliance by a lay person on a professional “cannot function as a substitute for compliance with an unambiguous statute.” Such reliance is not “reasonable cause” for a late filing or payment, the Court stated.


However, the Court also recognized that a taxpayer’s “disability” could provide reasonable cause for failure to meet a tax obligation:

The administrative regulations and practices exempt late filings from the penalty when the tardiness results from postal delays, illness, and other factors largely beyond the taxpayer’s control. . . . This principle might well cover a filing default by a taxpayer who relied on an attorney or accountant because the taxpayer was, for some reason, incapable by objective standards of meeting the criteria of “ordinary business care and prudence.” In that situation, however, the disability alone could well be an acceptable excuse for a late filing.

But the present case, the Court noted, did not involve the effect of a taxpayer’s “disability”; rather, it involved the effect of a taxpayer’s reliance on an agent employed by the taxpayer.

Case Law Defines “Disability”

In contrast, and by way of illustration, the Court described a case in which a company’s failure to file its taxes was excused by the fact that its principal decision-makers with regard to financial and tax matters were embezzling from the company.

The company had challenged penalties it was assessed for non-payment of taxes as a result of embezzlement committed by its CEO and its CFO. The government attempted to hold the company responsible under a strict “vicarious liability” theory.[iii]

The court acknowledged that a taxpayer’s duty to file its taxes is non-delegable, but it held that the officers’ criminal conduct divested them of their apparent authority on tax matters, rendering a vicarious liability theory inappropriate.

Significantly, however, the Court explained that this did not end the inquiry, because “[i]f a corporation has lax internal controls or fails to secure competent external auditors to ensure the filing of timely tax returns and deposit and payment of taxes, it fails to show reasonable cause or absence of willful neglect and is itself liable for statutory penalties, notwithstanding its lack of vicarious liability for the criminal actions of its agents.”

The Court then described another case, in which a business’s office manager/controller failed to ensure that the company timely fulfilled its employment tax filing and payment obligations over a period of years. When the manager received IRS notices of late penalty fees, neither the company’s officers nor its accountants were aware of the assessments because manager intercepted and screened the mail. Additionally, manager altered check descriptions and the quarterly reports when the assessments were later paid – the alterations made it appear that the tax payments were solely for the current period. The manager also concealed the deficiencies by personally undertaking the performance of all payroll function, and telling payroll clerks not to prepare the tax deposit checks anymore.

Even though the wrongdoing was all manager’s, the court noted that manager had only limited power in conducting their duties; importantly, to issue a payroll tax check, manager either had to have it signed by the company’s president and majority shareholder, or sign it themselves with a countersignature from the company’s corporate secretary.

The company only became aware of the delinquency after manager’s sudden resignation. After paying the penalty, the company filed suit seeking a refund on the basis that its manager’s “intentional misconduct disabled it from adhering timely to its tax obligation.”

However, the court explained that a corporate agent’s failure to act as they were supposed to only excuses the corporation’s failure to pay if the company “can show that it was disabled from complying timely.” It rejected the claim that manager’s actions disabled the company. The court held that manager’s “deficient and improper conduct was not largely beyond [company’s] control” because manager was subject to the supervision of both the owners and the company’s outside accountants. The court therefore held that there was no reasonable cause for company’s delinquency.


Applying the foregoing cases to the instant facts, the Court concluded that an agent’s failure to fulfill their duty to their principal to file tax returns and make payments on behalf of the principal does not constitute reasonable cause for the principal’s failure to comply with its tax obligations, unless that failure actually rendered the principal “disabled” with regard to its tax obligations.

The Court also concluded that establishing “disability” is a high bar that is not satisfied if the delinquent[iv] agent is subject to the control of their principal, whether that principal sufficiently exercised that control or not.

Though LLC argued that Manager’s dishonesty “incapacitated” LLC and rendered it unable to file its tax returns and pay taxes due, the Court found that Manager worked within a corporate structure in which they fell under the supervision of at least one person – the company’s owner.

Therefore, LLC was not disabled, and even if it was, its disability was not brought about by circumstances beyond its control. As such, Manager’s actions did not constitute reasonable cause.

Based on its conclusion that Manager’s actions did not constitute reasonable cause for LLC’s compliance, the Court rejected LLC’s argument that the district court erred by dismissing the case.[v]


The foregoing discussion considered the imposition of penalties on an employer-business for its failure to remit employment taxes notwithstanding that such delinquency was attributable to a “responsible” employee’s dishonesty.

Switching gears, how does the foregoing discussion affect the analysis of a principal’s “responsible person” status under the Code? Does the Court’s holding preclude any argument that an owner of a business may avoid such status if they have delegated their authority to an officer-level employee? Or does it limit this defense to situations in which the errant employee has “disabled” the business for tax purposes?

The Code provides that any person required to collect, truthfully account for, and pay over employment tax, who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.[vi]

In general, an individual cannot escape responsible person status simply by delegating most of their authority over the taxes and finances of the business to a key employee. The result may be different, however, where the following criteria are met: the individual is the equivalent of a limited partner – with no legal authority over such matters – or has contractually released any such authority, and can establish that they have not actually exercised such authority.[vii] In other words, where they have intentionally and legally “disabled” themselves.[viii]

Of course, the facts and circumstances of each situation are relatively unique, and it will be rare to encounter a closely held business in which each of the above criteria are satisfied by every owner. Someone will be held accountable, whether they are thrown under the proverbial bus or otherwise.

[I] LLC also asserted that its reliance on an outside CPA for “tax advice” excused its late payment and filing.

[ii] LLC also claimed that it had relied on its outside CPA to confirm that all employment taxes were being paid and all returns were being filed.

[iii] This is a form of secondary liability that arises under the common law doctrine of agency and which makes the principal responsible for the acts of their agent.

[iv] Hope you’re picking up on some of the puns here.

[v] LLC’s reliance on its outside CPA’s statements was also not a basis for relief. The information sought from the outside CPA was not advice about a complicated matter that required tax expertise, but instead a factual question as to whether LLC’s taxes had been filed and paid. LLC made no allegation that the accountant provided any information to LLC other than that the ministerial act of filing and paying taxes had been accomplished.

Although advice from a tax professional can, in some circumstances, provide a basis for reasonable cause for the nonpayment of taxes, LLC could not claim reliance on expertise of that sort. LLC relied on a mere factual representation by its CPAs that could have been readily verified or disproven; LLC did not rely on expert advice.

[vi] IRC Sec 6672.

[vii] Ah yes, proving a negative.

[viii] As distinguished from having stuck their head in the sand.