Opinion
CV-N-01-0225-DWH-VPC.
May 12, 2004
FINDINGS OF FACT, and CONCLUSIONS OF LAW
This case came on regularly for trial on April 14, 2004, before the court sitting without a jury. Jeremy N. Hendon and Traci L. Patterson appeared as counsel for plaintiff. Defendant appeared pro se. The court, having heard the testimony and examined the proofs offered by the respective parties, and the cause having been submitted for decision, makes its findings of fact as follows:
FINDINGS OF FACT
It is true that:
1. On May 6, 1991, the Internal Revenue Service (IRS) assessed David J. Smith (Smith) pursuant to 26 U.S.C. § 6672 in the amount of $1,082,496.52 (the assessment) on the ground he was a "responsible person" who "willfully" failed to pay payroll taxes collected by Texas Automatic Sprinklers, Inc. (Texas) from its employees.
2. Notice of the assessment was properly given.
3. The assessment has not been fully paid.
4. The assessment was for unpaid federal employment tax liabilities of Texas for the quarters ending December 31, 1987, March 31, 1988, June 30, 1988, September 30, 1988, December 31, 1988, March 31, 1989, and June 30, 1989.
5. The tax period at issue, therefore, is from October 1, 1987 through June 30, 1989 (the period at issue).
6. Texas, a Delaware corporation, was in the business of fabricating and installing fire-protection systems in commercial buildings.
7. All of its stock was owned by First Transact Investment Corporation (First), a Texas corporation.
8. All of First's stock was owned by The Mills Jennings Company (Mills Jennings).
9. Smith was one of four Mills Jennings shareholders. He owned 16% of Mills Jennings in 1985. His percentage of ownership declined after that.
10. From December 1986 until April 6, 1989, Smith was chairman of the board of directors and president of Mills Jennings.
11. Mills Jennings directly or derivatively owned a number of other corporations and routinely made Smith chairman of the board of each. He was not involved in the day to day operations of any of them except for those involved in the gaming industry.
12. W-2s in evidence show Smith was paid $41,800.00 by Texas and $148,545.01 by Mills Jennings for the year 1987, during which year he was chairman of each company's board of directors.
13. On April 6, 1989, the stock of First was purchased by a company named First Fire Protection Company (First Fire). The purchase agreement contains this sentence: "First Fire agrees to indemnify any officers of [Texas] from any personal liability including but not limited to David J. Smith and Logan L. Knight." In his resignation letter to Texas, dated April 5, 1989, Smith wrote that he resigned from "any and all positions" he held with Texas. Apart from whatever inferences one might draw from these passages as to whether Smith was an officer of Texas, there is no other evidence that Smith was ever an officer of Texas, much less what office he might have held, or what the authority or duties of that office might have been. To the contrary, resolutions of the board of directors of Texas, in evidence in this case, identify that other individuals served as Texas's officers. Pl. Ex. 21, 23, 25. Smith also testified that he never served as an officer of Texas, an assertion consistent with his prior representations to the IRS in this matter. Pl. Ex. 43. Thus Smith has proved by a preponderance of the evidence that he was never an officer of Texas.
14. On April 6, 1989, just before Smith's resignations were accepted, the board of Texas authorized the filing of a petition in bankruptcy.
See Pl. Ex. 35. The board authorization, on bankruptcy counsel's stationery, was more likely than not misdated by him.
15. December 8, 1986 board minutes of First show Smith to have been designated "attorney-in-fact" for First "in voting any and all shares of stock of [Texas] and Republic Fire Sprinklers, Inc. which are owned by [First]," at the stockholders' meetings of those companies. This language suggests the power of attorney was limited. However, the power is not in evidence and the relevance of these minutes to the issues in this action has not been shown.
16. December 8, 1986 board minutes of Texas show Smith to have been designated "attorney-in-fact" for Texas in voting any and all shares of Sprinkler Equipment Company owned by Texas, at stockholders' meetings of that company. This language suggests the power of attorney was limited. However, this power also is not in evidence and the relevance of these minutes to the issues in this action has not been shown.
17. Logan Knight was appointed president of Texas on July 17, 1987, by unanimous consent of its directors in lieu of a meeting.
18. From then until June 30, 1989, Mr. Knight made the day to day decisions for Texas, inter alia, the hiring and firing of personnel, the payment of the company's obligations, including tax obligations, and the preparation of its payroll tax returns.
19. Knight "acting on his own accord, without [consulting anyone] made the decision not to pay Federal Employment (941) taxes for the tax quarters commencing with the last quarter of 1987 through and including the second quarter of 1989." Def. Ex. 3. (Knight's affidavit, impeaching his testimony at trial).
20. First, as sole shareholder of Texas, on October 21, 1987 appointed Smith a director and board chairman of Texas. Pursuant to his power of attorney (see Finding No. 16), Smith executed the shareholder consent to this and other appointments.
21. As chairman of each of Mills Jennings held corporations, including Texas, Smith visited each, usually, once a month. From October, 1987, until April, 1989, when he resigned as chairman of all boards of Mills Jennings subsidiaries, he visited the offices of each subsidiary, including Texas, every month or two.
22. Richard Arnold was employed by Mills Jennings to do work connected with Texas at Texas's offices in Dallas from May to October, 1987, when he was dismissed. On May 1, 1989, he wrote a letter (Pl. Ex. 41) to the Internal Revenue Service denying any responsibility for Texas's payroll taxes and offering defendant as the party responsible for them. The letter verges on the defamatory and is so far inconsistent with another letter (Pl. Ex. 38) he wrote to Smith during his employment, the court doubts the truth of its content. Moreover, its relevance even if true is severely limited: Arnold was fired only days into the fourth quarter of 1987.
Arnold did not testify at trial. Certain of his deposition testimony was offered by plaintiff, including testimony concerning his May 1, 1989 letter. That testimony showed the letter (Pl. Ex. 41) to be only past recollection recorded. It was read into the record. See Fed R. Evid. 803(5).
23. No office space for Smith was ever maintained at Texas.
24. For an unspecified period in early 1989, in the interest of efficient use of resources, Texas and Mills Jennings shared office space, office staff, and telephone numbers in Reno, Nevada.
25. It has not been proved that Smith ever was an officer of Texas or of any other corporation owned by Mills Jennings.
26. Smith never directed the preparation of Texas's payroll.
27. Smith was not a signatory on any bank account of Texas.
28. Smith neither prepared nor signed any Texas payroll tax return.
29. There is no evidence of the authority of Smith as board chairman under Texas's bylaws.
30. There is no evidence of the authority of Smith to ensure the tax delinquency was paid other than by direction of the board of Texas.
31. Smith routinely reviewed the quarterly financial statements of each subsidiary.
32. Smith first learned that Texas was delinquent in paying its payroll tax in mid-August, 1988, when Knight told him that Caroline C. Gaither, a United States Internal Revenue Officer in Dallas, wanted to meet with Knight and him concerning the delinquency.
33. Smith consulted with the Texas directors and the board decided to form a very strong plan to pay the arrearage.
34. Smith promptly went to Dallas and, together with Knight, met with Ms. Gaither.
35. On his return to Reno, Smith wrote to Knight, in pertinent part, as follows:
As I told you at our meeting last week, I am very disappointed to learn that [Texas] has not been depositing payroll taxes when due. As we discussed last week, you have identified and will implement overhead reductions to eliminate your cash flow problems. You are hereby directed to make all tax deposits when due from this point forward with no exceptions. In the event you do not, we will close down [Texas] immediately. During our meeting, we discussed some alternatives for paying off the taxes that have not been paid. This should be your second priority with your first priority focused on making sure all tax deposits are made timely. You identified factoring of the company's receivables as the quickest way to pay off these old taxes. You need to move forward quickly to complete the factoring and you should also use any excess cashflow to reduce the old tax balance. You must do everything in your power to pay the accrued tax liability that is now in existence. Pl. Ex. 33.
36. By October, Texas had reached an agreement with American Trade Partners, a factor, for the purchase of certain accounts receivable of Texas, and an agreement with plaintiff through Ms. Gaither for the initial payment of $200,000.00, and installment payments thereafter, on the payroll tax arrearage.
37. Based upon his conversation with Ms. Gaither, Smith expected she would advise him if the agreement were not being kept by Texas.
38. Not long after, Texas stopped performing its agreement with plaintiff, but Smith was not advised.
39. Smith continued to monitor the performance of Texas's agreement with the IRS by examining copies of Form 941 filed by Knight on Texas's behalf. These forms showed no tax arrearages. Smith also examined copies of the checks by which Knight made monthly payments on the arrearages to the IRS.
40. Smith also conducted his own investigation into how the tax delinquency might have been shown on Texas's books. He discovered that some liabilities were accrued in an account labeled "Billings in Excess of Cost," which typically was used to accumulate construction contract costs. Given the usual use of such accounts, he concluded that the balances seemed appropriate. Smith later concluded that this account was used by Knight to hide Texas's tax delinquencies from Mills Jennings and its auditors.
41. In late March, 1989, Knight called Smith
"with . . . an extremely startling revelation . . . [:] he [said he] had misinformed and mistated to [Smith] the true situation regarding the accrued and accruing payroll tax liabilities of [Texas]. . . . [T]hat, in fact, not all the taxes had been paid or timely deposited for payrolls becoming due in the fourth quarter of 1988 and the first two months of 1989." Pl. Ex. 43.
42. On August 17, 1987, Smith as its president signed the "Mills Jennings Co. Subsidiaries" Form 1120 U.S. Corporation Income Tax Return for the tax year December 1, 1985 to November 30, 1986. This return included Forms 1122 (Authorization and Consent of Subsidiary to be Included in Consolidated Income Tax Return) for each subsidiary. Smith signed the Texas 1122 as its chairman.
43. In March or April of 1989, Smith as president and a director of Mills Jennings approved a "gift" of Mills Jennings funds equal to an approximate $70,000.00 Texas payroll to Texas employees at a time when Smith knew that Texas had outstanding employment tax liabilities.
44. Credits and payments in the amount of $901,808.27 have been paid and applied to the balance of the Assessment. Smith has involuntarily paid nearly all of this.
45. The unpaid balance of the assessment as of May 30, 2003 was $148,385.67 as of May 30, 2003. The total balance due as of April 13, 2004, with interest and other statutory additions as provided by law, is substantially more: $1,861,257.43.
46. Smith owes plaintiff none of this because he has proved by a preponderance of the evidence that he was never and is not a section 6672 "responsible person" who "willfully" failed to pay the tax.
The foregoing Findings of Fact, insofar as they may be considered Conclusions of Law, shall be so considered. The following Conclusions of Law, insofar as they may be considered findings of fact, are found to be true in all respects.
From the foregoing facts the court concludes:
CONCLUSIONS OF LAW
1. The Court has jurisdiction over this action under 26 U.S.C. § 7402 and 28 U.S.C. § 1340 and 1345.
2. Employers who are required to withhold federal taxes from employee wages during each pay period must hold those funds in trust for the federal government and pay them over quarterly. Buffalow v. U.S., 109 F.3d 570, 572 (9th Cir. 1997) (citing 26 U.S.C. § 3102(a), 3402(a)).
3. When an employer fails to pay over the trust fund taxes, the IRS has several means at its disposal for collecting the amount owed, including the penalty provisions of 26 U.S.C. § 6672. See Slodov v. U.S., 436 U.S. 238, 243-44 (1978).
4. In pertinent part, 26 U.S.C. § 6672(a) provides as follows:
Any person required to collect, truthfully account for, and pay over any tax imposed by this title 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, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.
5. For purposes of this section, the term "person" includes an officer or employee of a corporation who is "under a duty to perform the act in respect of which the violation occurs." 26 U.S.C. § 6671(b).
6. Therefore, "an employer-official or other employee responsible for collecting and paying taxes who willfully fails to do so" is subject to the penalty under § 6672. Slodov, 436 U.S. at 245. Courts refer to a "person required to collect, truthfully account for, and pay over" the trust fund taxes as a "responsible person." Id. at 246 n. 7.
7. An official certificate of assessment (Form 4340) is considered highly probative and sufficient to establish that the assessment was proper absent evidence to the contrary. Hughes v. U.S., 953 F.2d 531, 535 (9th Cir. 1991). The United States has provided such a certificate in this case.
8. The government established a prima facie case by introducing a certificate of assessment. `Pl. Ex. 1. The burden of proof then shifted to Smith to "prov[e] by a preponderance of the evidence that one or both of [the elements of responsibility and willfulness] is not present." U.S. v. Jones, 33 F.3d 1137, 1139 (9th Cir. 1994) (second alteration in original); Larson v. U.S., 76 F. Supp.2d 1092, 1095 (E.D. Wash. 2000).
9. The recovery of a penalty under Section 6672 involves a two-step inquiry. First, it must be determined whether the person assessed is a "responsible person" within the meaning of Section 6672. Second, it must be determined whether the person assessed acted "willfully" in failing to collect or pay over the withheld taxes within the meaning of Section 6672. See Davis v. United States, 961 F.2d 867, 869-70 (9th Cir. 1992); Buffalow v. United States, 109 F.3d 570, 573 (9th Cir. 1997).
10. More than one person can be found to be a "responsible person" for any given quarter, and liability under Section 6672 can be imposed on each for any given quarter. See Turner v. U.S., 423 F.2d 448, 449 (9th Cir. 1970).
11. Responsibility is a matter of "status, duty, and authority, not knowledge." Davis v. U.S., 961 F.2d 867, 873 (9th Cir. 1992). A person is "responsible" if he or she has the "final word" on which bills should or should not be paid, meaning "the authority required to exercise significant control over the corporation's financial affairs, regardless of whether [the individual] exercises such control in fact." Jones v. U.S., 60 F.3d 584, 587 (9th Cir. 1995).
12. An individual's lack of involvement in day-to-day financial decision making or tax matters "is irrelevant where that individual has the authority to pay or to order the payment of delinquent taxes." Purcell v. U.S., 1 F.3d 932, 937 (9th Cir. 1993).
13. Courts sometimes invoke a non-exclusive list of "factors" in determining responsibility, such as whether the individual had authority to sign checks, served as an officer or director, and could hire and fire employees. See, e.g., U.S. v. Jones, 33 F.3d 1137, 1140 (9th Cir. 1994) (citing Hochstein v. U.S., 900 U.S. 543, 547 (2d Cir. 1990)). The "most critical factor," however, remains having significant control over the corporation's finances. Id.
14. A responsible person need not actually exercise his control over corporate affairs; the mere ability to exercise that control establishes responsibility. See Jones, 33 F.3d at 1139; see also Purcell, 1 F.3d at 937.
15. Willfulness is shown by "a voluntary, conscious and intentional act to prefer other creditors over the United States. No bad motive need be proved, and conduct motivated by reasonable cause, such as meeting the payroll, may be willful." Buffalow v. U.S., 109 F.3d 570, 573 (9th Cir. 1997) (internal quotations omitted).
16. Where a responsible person makes a deliberate decision to pay other creditors, while knowing that the trust fund liability is outstanding and unpaid, that person acts willfully under § 6672. See Buffalow, 109 F.3d at 573. As the Ninth Circuit has explained,
[i]f a responsible person knows that withholding taxes are delinquent, and uses corporate funds to pay other expenses, even to meet the payroll out of personal funds he lends the corporation, our precedents require that the failure to pay withholding taxes be deemed "willful." This may seem oppressive to the employer and employees, and amount to "unwittingly" willful, which seems an oxymoron, but the proposition is established law.Phillips v. U.S., 73 F.3d 939, 942 (9th Cir. 1996) (citations omitted).
17. After a responsible person knows of the unpaid tax liability, any money coming into the corporation, from any source, must be paid to the United States to satisfy both current and accrued taxes. See Teel v. U.S., 529 F.2d 903, 905 (9th Cir. 1976); see also Davis, 961 F.2d at 876.
18. Willfulness also may be established where a responsible person has no knowledge that other creditors are being satisfied while taxes are delinquent, yet acts with "reckless disregard" of whether the trust fund taxes are being properly paid over. See Phillips, 73 F.3d at 942. Although mere negligence will not suffice to show "reckless disregard," id., a responsible person may be held liable if he clearly ought to have known of a grave risk that taxes were not being paid and was in a position to find out very easily, or failed to investigate or correct mismanagement after being notified of a delinquency in payment. See id. at 943.
19. Notice with respect to the Assessment against Smith in this case was properly given.
20. Smith was not a person responsible for collecting, truthfully accounting for and paying over to the United States the payroll taxes withheld from Texas's employees for the tax period at issue. Although Smith was Chairman of the Board of Directors of Texas and of Texas's parent company, Mills Jennings, at all relevant times, Smith did not have the "final word" on which of Texas's bills would be paid. Smith was not an officer of Texas, did not control its day-to-day financial affairs, did not have the ability to sign its checks, and otherwise lacked authority to direct the payment of Texas's delinquent tax liabilities, other than in his role as Chairman of Texas's board. Smith's role did not allow him to exercise significant control over Texas's finances. Thus Smith is not a "responsible person" for purposes of § 6672.
21. Even if Smith were considered a "responsible person," he did not act willfully, or with reckless disregard, in failing to pay over the delinquent taxes during the period at issue. Smith did not prepare payroll, sign payroll checks, or direct the payment of other creditors at any time after learning of Texas's payroll tax delinquency. Smith took detailed steps to ensure that Logan Knight took steps to address the deficiency and remained current on the payroll taxes thereafter, steps that might have proved successful if not for Knight's concealment of the continuing arrearages.
22. After Smith learned from Knight in March 1989 that Texas's tax liabilities remained unsatisfied, Mills Jennings conferred a "gift" on employees whom Texas was unable to pay. This gift does not establish willfulness because Mills Jennings funds were given directly to the employees, without passing through Texas. Smith did not direct a loan from Mills Jennings to Texas for this purpose, nor did he direct Texas funds to the employees, at a time when he knew that the tax liabilities remained unsatisfied. Cf. Phillips v. U.S., 73 F.3d 939, 942 (9th Cir. 1996).
23. Smith also did not act with reckless disregard as to whether Texas's employment taxes had been paid. Upon learning of the delinquency in August 1988, Smith took immediate steps to address the problem, including meeting with the IRS, directing Logan Knight to pay the past due taxes immediately and remain current in the future, and assisting Texas (in his capacity as Chairman of Mills Jennings) in negotiation of an agreement to factor Texas's accounts receivable. Smith also continued to monitor the situation, examining copies of Texas's Form 941 filings for the last two quarters of 1988 and conducting an independent review of the company's balance sheets. Although Smith knew of a grave risk that the taxes might not be paid, he was not in a position to find out easily whether they were being paid because of Logan Knight's successful concealment of the continuing liability.
24. Smith is not liable to the United States for a trust fund recovery penalty under 26 U.S.C. § 6672.
Let judgment be entered accordingly.