A fundamental aspect of business law is limited liability. Business owners want to shield themselves personally from the inherent business risks associated with interacting with the public or selling products and services. Accordingly, business owners set up legal entities such as corporations or limited liability companies to create a corporate veil between their personal activities and their business activities.

Absent some type of personal guaranty, the corporate veil will protect a business owner’s personal assets in the event the business’s liabilities exceed its assets. For example, if a customer won a lawsuit against Grocery Store, LLC because the customer slipped on a grape and injured himself and Grocery Store, LLC had to declare bankruptcy, the corporate veil that the owner of Grocery Store, LLC created by forming a limited liability company would protect the owner’s individual assets.

Several exceptions to the limited liability doctrine allow individuals, entities or governmental organizations to pierce the corporate veil. This article will focus on an exception related to the collection and remittance of certain trust fund taxes. Trust fund taxes are taxes that individuals owe but that businesses collect and remit to governmental organizations. The following are the most common trust fund taxes:

  • Withheld State and Federal Income Taxes;

  • Social Security and Medicare Taxes; and

  • Sales Tax.

With regard to withheld income taxes and Social Security and Medicare taxes, employers are responsible for withholding the taxes from their employee’s paycheck and remitting them to the appropriate governmental organization. With regard to sales tax, a business is required to collect the sales tax from the customer and remit it to the Wisconsin Department of Revenue (“WDOR”). In both instances, either the state or federal government entrusts businesses to hold the employee’s or customer’s taxes and properly remit them to the state or federal government.

If a business is not doing well, the person responsible for paying the bills may choose to forgo remitting the trust fund taxes to the government in lieu of paying employees or other vendors. Since the cash associated with the trust fund taxes is not actually the business’s asset, both the IRS and the WDOR have a statutory right to pierce the corporate veil and personally assess the “responsible person” who should have paid the trust funds taxes to the appropriate governmental organization. In particular, each governmental agency may assess penalties against any person who:

  • Is responsible for collecting or paying withheld or collected income, employment or sales taxes; and

  • Willfully fails to collect or pay them.

A responsible person is a person or group of people who has the duty to perform and the power to direct the collecting, accounting, and paying of trust fund taxes. This person may be:

  • An officer or an employee of a corporation;

  • A member or employee of a limited liability company;

  • A corporate director or shareholder;

  • A member of a board of trustees or directors of a nonprofit organization;

  • Another person with authority and control over funds to direct their disbursement; or

  • Another corporation or third party payer.

For willfulness to exist, the responsible person:

  • Must have been, or should have been, aware of the outstanding taxes; and

  • Either intentionally disregarded the law or was plainly indifferent to its requirements (no evil intent or bad motive is required).

Using available funds to pay other creditors when the business is unable to pay the employment, withholding or sales taxes is an indication of willfulness. The rules set forth above not only attach to owners, directors and officers, but also to employees who have no ownership or direct control over the operation of the company. If an employee has control over the payment of the taxes, the IRS or WDOR can find that he or she is a “responsible” person and can try to collect the taxes and penalties from the employee’s personal assets.

In addition to piercing the corporate veil, the IRS and WDOR can assess large penalties against a “responsible person”, which are not dischargeable via bankruptcy. In addition, the IRS and WDOR can criminally prosecute a “responsible person” for failing to remit trust fund taxes.

If a business owner utilizes trust fund taxes to finance their business, it will almost certainly end the business. The penalties and interest that the WDOR and IRS assess against non-payment of trust fund taxes are extremely high and often accrue faster than a business owner can pay them. The bottom line is that business owners should always remit trust fund taxes to the appropriate governmental agency.

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Written By:
Attorney James M. Ledvina

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