What is it and what can you do if you are a target?
Prior to Washington’s enactment of the Trust Fund Accountability Assessment in 1987 (TFAA), a corporation which had collected sales tax but had not paid it over to the state could usually close its doors, with its owners and employees having no personal liability for the unpaid tax. In other words, traditional rules of corporate limited liability protected shareholders and officers. The 1987 act changed that.
The 1987 legislation was largely patterned on federal law which has long imposed personal liability if an entity withholds payroll taxes from employee wages but does not pay them to the government. The new Washington law said that certain individuals, defined in the law as “responsible persons,” could be held liable for the sales tax which the corporation (that would now also include a limited liability company) had collected from customers but had not paid to the state. But the Washington law added a few twists to the federal law which makes it much broader than the federal statute, and a huge threat to business owners who fall behind in sales taxes.
The FIRST twist is that, where the federal penalty is limited to the amount of tax which was withheld from employee wages (which is considered held “in trust” until paid to the government), the Washington TFAA assesses not only liability for the sales tax (also considered held in trust until remitted to the state), but also includes liability for the penalties and the interest which has been assessed against the corporation /LLC. Of course, the penalties and interest assessed against the corporation are not trust fund amounts in any sense of the word, because they are not amounts collected from customers and held in “trust” until paid to the state. Still, they comprise part of the amount assessed against an individual. This is astonishing in scope, but whether the legislation was intentionally drafted to do this, or whether it was the result of an unintended drafting error, there has not been any interest in fixing it in over 25 years.
Consider what this means: Businesses are likely to be many months behind in paying sales tax by the time a TFAA arises, so that there are almost always delinquency penalties and interest due on the taxes. Even worse, in many instances where an audit has revealed that a business has a pattern of not remitting sales tax, the law also imposes an evasion penalty of 50% of the amount of the sales tax not remitted. Because of the mounting interest and these penalties, the liability ultimately assessed against the persons assessed with a TFAA can be staggering. Even worse, because of the economic downturn in the past few years, and the decline in state revenue, the incidence of the TFAA has grown and, along with it, so have criminal prosecutions. To cap off the litany of problems with TFAA, the assessment cannot be discharged in a bankruptcy.
A SECOND twist is this: federal law allows a taxpayer, in this case a corporation or LLC, which has withheld but not remitted payroll taxes, to designate how a voluntary payment is to be applied. So if a struggling business can make any payments, it can usually designate such payments for application to trust fund liability, and thereby somewhat limit the potential liability of individuals. But Washington law does not permit designation of payments made with respect to taxes, so a corporation’s payments are applied by Revenue in a more complicated manner. The common result is that payments are first applied to penalties and interest, and after that are applied by a formula to a combination of trust fund and non trust fund taxes.
Can anything be done to deal with a potential or actual trust fund penalty? Here are some suggestions:
- If the business is falling behind on bills which include potential federal and Washington trust fund amounts, discuss with a knowledgeable tax advisor possible strategies for order of payment.
- There are some defenses to the penalty, but they are tied to the specific facts, so it may be a good idea to meet with a tax advisor as soon as possible to evaluate possible ways to limit potential individual liability.
- If the business is scheduled for an audit which you think will disclose unpaid sales taxes, get in touch with a tax advisor asap. This is not only to get the number right in an audit, but to protect against damaging admissions.
- If you have received a TFAA, consider an appeal. There may be defenses available which can be brought out on appeal.
Learn more about Attorney Martin Silver, PS.