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September 21, 2021 At Court

Pyramiding Employment Taxes and Government Remedies

By T. Keith Fogg, Clinical Professor of Law, Harvard Law School

As employees, we often speak in terms of paying taxes to the IRS. In reality, however, employees actually pay those taxes to their employers who, in turn, pay the taxes over to the IRS. The system of tax collection in the United States relies heavily upon employers who are essentially appointed by statute to act as the agent of the IRS for the collection of both income and employment taxes through a withholding mechanism. The system, built as a result of the World War II influx of taxpayers, makes it easy for employees to pay in a rather painless fashion and provides the government with year-round payment of taxes. Nonetheless, the system is not as transparent as it perhaps should and could be.1

The system breaks down when the employer fails to pay over the taxes that it withholds from its employees. In most cases, the failure stems from a business model that has created a cash-flow shortage. Lacking cash to pay all its creditors, many business owners pay the government last because it is frequently the slowest creditor to voice concerns. While most business owners fail to pay the withheld taxes because a cash shortfall leads them to a business decision prioritizing other creditors, some business owners operate with a continuing business model of stiffing the IRS.2

This second group of business owners engage in a practice called pyramiding through which they operate for months, or years, on end without paying the withheld taxes. Sometimes they will even close one business and move to another when the IRS creates too much heat in its pursuit of the unpaid taxes. The traditional method for putting pressure on business owners to pay over withheld taxes is for the IRS to pierce the corporate veil and assess a liability against the individuals at the business who are responsible for failing to pay employment taxes. Section 6672 allows the IRS to make these assessments.

For some hardcore pyramiding businesses, even that assessment of personal liability is insufficient to stop the accrual of additional liabilities. Until a change in the law in the early 1980s, the IRS frequently engaged in no-equity seizures to shut down businesses that were pyramiding; however, the change in the statute currently prohibits the IRS from using no-equity seizures to shut down businesses.3 Following the end of no-equity seizures, the IRS searched for another tool to use to stop pyramiding. Working closely with the Department of Justice (DOJ) Tax Division and after many years of discussing the possibility, the IRS decided that it could bring an injunction action seeking to stop the pyramiding taxpayer from running up additional liabilities. Doing this through an injunction takes longer and costs more money from the perspective of the time and effort of the Department of Justice trial attorney but can prove an effective method of shutting down a business that continues to ignore the requirement to pay payroll taxes.

In the 2018 May Tax Meeting, the Civil and Criminal Tax Penalties Committee held a panel entitled “Employment Tax Liabilities and IRS Collections.” The panelists discussed the various tools that DOJ and IRS have to go after employers who pyramid employment tax liabilities by withholding taxes from employees but then failing to remit those taxes to the government. They also discussed the challenges that the government faces in trying to prosecute one of these cases. A high percentage of injunction cases seem to fit the bill for criminal prosecution, and DOJ does now prosecute people for failing to pay employment taxes—something it almost never did three decades ago. Nonetheless, it can be difficult to know what causes the decision to fall into the injunction box rather than the prosecution box.

The 2019 Askins & Miller Orthopaedics case4 demonstrates some of the challenges the government faces in shutting down a non-compliant business. The business was run by two brothers who had caused the business not to pay its employment taxes (both trust fund and non-trust fund) since 2010. To hide the business’s assets, the brothers also created trust and other entity accounts. In many ways, the case reads like a textbook case for a criminal prosecution against the brothers, but here the government chose the civil route. The district court, however, refused to impose an injunction.

The IRS has tried several collection strategies over the years. It started with an effort to achieve voluntary compliance: IRS representatives have spoken with the Askins brothers “at least 34 times” since December 2010, including 27 in-person meetings. Twice they entered into installment agreements that set up monthly payments to bring Askins & Miller back into compliance, but the company defaulted both times. Two other times, they warned Askins & Miller that continued noncompliance could prompt the government to seek an injunction.
The IRS has employed more aggressive means as well. It served levies on “approximately two dozen entities,” but most “responded by indicating that there were no funds available to satisfy the levies.” Three entities paid some money, but not nearly enough to satisfy Askins & Miller’s debts or to keep pace with its accrual of new liabilities. Additionally, the IRS’s ability to collect payments through levies has been hampered by the defendants’ attempts to hide Askins & Miller’s funds and to keep the balances in Askins & Miller’s accounts low. Between 2014 and 2016, the Askins brothers transferred money from Askins & Miller to “RVA Trust,” which operates a private hunting club for the brothers, and “RVA Investments,” an accounting business associated with their father. The IRS also discovered additional accounts at BankUnited and Stonegate Bank. It did not seek to levy RVA Trust, RVA Investments, or the bank accounts because it discovered them after this case had been referred to the Department of Justice and because the IRS believed that “there is a substantial risk that any new levy would result in [the defendants] opening new undisclosed accounts and moving the money there.”5

When the IRS finally gave up on its administrative collection efforts and referred the case to the DOJ for the pursuit of an injunction, it met another obstacle. The district court denied the motion without prejudice on finding the declaration conclusory and the proposed injunction “effectively an ‘obey-the-law’ injunction.” The IRS filed a new declaration with the district court, trying again to convince it to enjoin the taxpayer’s actions. The district court again reached the conclusion that the requested injunction served as an order to obey the law. After the second attempt at the district court, the IRS appealed. While the case was pending in the district court, the taxpayer ran up even more liabilities.

To obtain a preliminary injunction under “the traditional factors,” the IRS must demonstrate (i) a substantial likelihood of success on the merits, (ii) that it will suffer irreparable injury unless the injunction is issued, (iii) that the threatened injury to the IRS outweighs whatever harm the proposed injunction might cause the defendants, and (iv) that the injunction would not be adverse to the public interest. The district court noted that the parties essentially agreed that the facts of the case met three of the four traditional elements for an injunction case. The court considered that the IRS could obtain a judgment for damages, however, so it did not face irreparable injury. The IRS argued that such a judgment was meaningless in this case because it had already exhausted its administrative efforts with its powerful administrative tools in trying to collect the outstanding debt.

On appeal, the Eleventh Circuit reversed the district court decision, holding that the government had proved its case for imposing an injunction. Mootness regularly upends injunction cases as business owners hop from one business entity to another to stay ahead of the IRS collection efforts. Here, the appellate court first slapped away the taxpayers’ attempted mootness argument.

Given the undisputed facts before us, we do not believe that the defendants can satisfy their “heavy” and “formidable” burden of making it “absolutely clear” that their behavior will not recur.6

Next, the appellate court addressed the district court’s main concern that the injunction was simply an obey-the-law order.

Finally, the proposed injunction goes well beyond merely requiring compliance with the employment tax laws. In fact, it lists numerous concrete actions for the defendants to take — to name only a few, segregating their funds, informing the IRS of any new business ventures, and filing various periodic affidavits — well beyond what a simple “obey-the-law” injunction would look like. In short, this case does not raise the sort of fair notice concerns that Rule 65(d) is designed to address.7

The fact that the IRS appealed the case to circuit court shows how important it views the injunction remedy and how concerned it was with letting the district court precedent stand. Winning on appeal provided a boost to the IRS in seeking injunctions in similar circumstances, leading to its most recent victory in Potoroka Concrete.8 There, the IRS won an injunction case the easy way: the defendants failed to contest the injunction request.

The concrete business in the case had failed to pay its employment taxes for more than three years. The IRS had already obtained an assessment against the owner under section 6672. In the absence of a contest, it was successful in obtaining the injunction language it sought. That language is instructive. First, it obtained a judgment against the business and the individual for the unpaid taxes. Obtaining the judgment keeps the statute of limitations on collection open much longer and gives the IRS more collection options. Next, the injunction included a litany of actions the business and individual were ordered to perform, including withholding and paying over the proper amount from any paycheck issued, timely depositing the taxes, doing the same for any entity the business or individual controls, delivering affidavits to the Revenue Officer of compliance, timely filing of employment tax returns, and not paying other creditors until after the taxes are paid. The court required the delivery of the order to all employees so that the employees would know of the company’s past failures and future responsibilities.9 The court also retained jurisdiction to monitor future compliance and provided detailed instructions regarding IRS actions in the event of a default and the court’s responses, including holding the responsible officer in contempt of court.

The Potoroka case shows that the IRS will continue to aggressively seek to stop pyramiding companies if it has the resources to put together injunction cases. Because the taxpayer did not contest the injunction, the Potoroka case does not provide insight into areas of problems the IRS may face in these cases. Even though it now has the injunction, $200,000 of unpaid taxes remain in this case.

Making sure that employers collecting taxes on behalf of the IRS fulfill their responsibilities requires constant vigilance by the IRS. The withholding system is great when it works, but many decades of experience show that some employers will not fulfill their responsibilities without aggressive oversight. 

Endnotes

  1. See T. Keith Fogg, Transparency in Private Collection of Federal Taxes, 10 Fla. Tax Rev. 763 (2011).
  2. See generally T. Keith Fogg, In Whom We Trust, 43 Creighton L. Rev. 357 (2010).
  3. § 6331(f).
  4. United States v. Askins & Miller Orthopaedics, P.A., 924 F.3d 1348 (11th Cir. 2019).
  5. Id. at 1352.
  6. Id. at 1357.
  7. Id. at 1362.
  8. United States v. Potoroka Concrete LLC, 127 AFTR2d 2021-826 (E.D. Mich. 2021).
  9. It is worth noting here that if the company withholds from an employee, the employee is not liable to the IRS if the company fails to pay over the withheld taxes. This treatment is consistent with the general theory that in the collection of taxes the employer serves as the agent of the IRS and not the employee.
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