Episode 433: Navigating Personal Liability: The Impact of Unpaid Employment Trust The Legal Play

Most employers understand that the US government expects them to collect employment and excise taxes from their employees’ pay, and that this withholding is to be paid over to the IRS. It can be tempting to use this money towards other business expenses, but employers should resist the impulse. Not all employers realize the impact of unpaid employment trust and how that relates to personal liability. The fact of the matter is if the employment trust isn’t paid, managers can be held personally liable to the IRS.





How Unpaid Employment Trusts Can Affect Personal Liability

The impact of unpaid employment trusts can be enormous for individuals. Despite the expectation that a business filing bankruptcy will extinguish all debts, including to the IRS, this is not the case. And even if the business itself has gone bankrupt and cannot pay employment trust liability, the IRS will find someone to hold personally liable for that debt. Much of this standard was set by the case of Begier vs the IRS from 1990. While it is a bit of an older case, it still sets the precedent and is very much applicable today.



However, before we break the case down, it is important to establish a couple of talking points first:



* Trust fund taxes are essentially employment withholding taxes due to the Internal Revenue Service.

* Employers pay their employees but hold some money out of those payments to pay the government taxes such as FICA, Social Security, and Medicare. This is called an employment trust. (Contrary to popular believe, a trust is not just something established by a person in the event of their death or incapacitation.) At its root, the definition of trust means having someone hold onto something for the benefit of another.



Now, back to Begier vs the IRS. In this situation, American International Airlines fell behind in paying its employment trust fund taxes, which the Internal Revenue Service was aware of. It was not a small sum by any standard. The airline eventually filed for Chapter 11 bankruptcy. For the first 90 days of the bankruptcy, they acted as a debtor in possession and, during that time, decided to reconcile the trust fund money they owed to the IRS. After 90 days, the court appointed a trustee to come in and take over for existing management.



When the appointed trustee found out about the large sum of money the airline had paid to the Internal Revenue Service when there were many debts still owed to other airline creditors, the trustee sued the IRS to attempt to recover the money. The argument the trustee made was that the IRS was no more superior to other creditors and thus should not get priority over available funds.



The court in Begier held that the money held in trust was never the airline’s money to begin with. So when they went into bankruptcy, those employment trust funds were not part of the “debtor’s estate.” The trustee was not able to recover those funds



But the bigger question is why the airline managers decided to pay off employment trust taxes rather than pay off some of the other airline creditors, especially knowing that some of the other debts were just as large, if not larger, than the IRS debt. While the intentions of the managers cannot be known exactly, it is very likely that they understood that if that particular debt was not paid before the company had no money left, that debt would not be extinguished in the bankruptcy and the human individuals responsible for running the business would be held personally liable for those debts for years to come.



This is important, so we will repeat it again: business managers who are signatories on the company bank account and the people responsible for signing the checks to the IRS, known as “responsible parties” ,