You may have heard of one of the harshest tax laws, formerly known as the “100% penalty”. This penalty can be assessed against a responsible person when federal income tax and/or federal employment taxes are withheld from an employee’s paycheck but aren’t given to the government. The objective of the penalty is to collect withheld and unpaid federal taxes from individuals who had control over an employer's finances.
Determining Who's Responsible
The “100% penalty” can only be assessed against a so-called responsible person. That could be a shareholder, director, officer or employee of a corporation; a partner or employee of a partnership; or a member (owner) or employee of a multi-member LLC. It can also be assessed against an employee of a sole proprietorship or an employee of a single member (one owner) LLC.
To be charged with the penalty, the individual must:
- Be responsible for collecting, accounting for, and paying withheld federal taxes, and
- Willfully fail to remit those taxes (willful means intentional, deliberate, voluntary and knowing, as opposed to accidental).
A person who is being assessed for the “100% penalty” isn’t responsible simply by having the authority to sign checks when directed by a superior. The individual in question must have knowledge of and control over the finances of the business. In these situations, the IRS will evaluate individuals with check-signing authority.
Below are factors that the courts will examine beyond the authority to sign checks to determine who had responsible person status:
Those factors include whether the individual:
- Is an officer or director,
- Owns shares or has an entrepreneurial stake in the company,
- Is active in managing the day-to-day affairs of the company,
- Can hire and fire employees,
- Makes decisions regarding which, when, and in what order debts or taxes will be paid, and
- Exercises daily control over bank accounts and disbursement records.
It is important to note that lenders and advisors can also be responsible persons. For instance, the executor of a decedent’s estate was found to be a responsible person when the operators of an inn failed to remit withheld federal taxes.
Consult with a Qualified Tax Advisor
As previously stated, the “100% penalty” is known to be one of the harshest tax laws. By ensuring that the IRS is paid fully for employment taxes, you avoid serious financial consequences. In all cases, it is essential to consult with your tax advisors about what records you should be keeping to avoid this expensive penalty.
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