When determining whether to assess a trust fund penalty, the IRS must establish both responsibility and willfulness. According to the IRS’s Internal Revenue Manual, “willfulness” means intentional, voluntary, deliberate, and knowing. Evidence of evil intent or bad motive is not required and the government must demonstrate that 1) the responsible person acted intentionally by opting to pay other creditors over taxes, or 2) the responsible person’s conduct was grossly negligent or in reckless disregard of the law.
The IRS can satisfy the element of willfulness by proving that a responsible officer was aware or should have been aware of the outstanding taxes and either intentionally did not pay it or was indifferent to the requirements. In the IRS’s eyes, a taxpayer acted willfully when he or she fails to pay taxes after being put on notice that taxes need to be paid.
Consequently, a critical element in establishing willfulness centers on when and if the taxpayers were made aware of the payroll delinquencies. If there was never a history of delinquency to put the taxpayer on notice, then a failure to inquire about the status of taxes does not equal reckless disregard of the law. Some courts state that a taxpayer who does have notice that taxes were not properly submitted to the IRS also has a duty to inquire, investigate and correct the mismanagement. If they do have notice and didn’t do these things, then they are no longer just merely negligent and displayed gross negligence proving the element of willfulness.
There are several ways a taxpayer can take defense against willfulness element of the trust fund penalty (although the below defenses may vary by jurisdiction):
1) The taxpayer can show that he or she was merely negligent. In most cases, the taxpayer will have to show that he or she did not have actual knowledge that the liability existed and remained unpaid.
2) The taxpayer can show reasonable cause for not paying the taxes. In most cases, the taxpayer will have to show that he or she made reasonable efforts to pay the trust fund taxes but those efforts were undermined by circumstances beyond their control.
3) The taxpayer lacked knowledge that the trust fund taxes were not being paid unless it is proven there was reckless disregard. (This is similar to defense #1)
4) The taxpayer proves that there were no unencumbered funds available from the business at the time he or she became a responsible person. (This only applies in some jurisdictions and the taxpayer must be a newly responsible person and all or a majority of the funds must have been unavailable.)
5) The taxpayer lacked financial control. This also applies in some jurisdictions and the taxpayer must prove that he or she was not occupying a central role in the financial affairs of the company and therefore, had no ability to pay or see to it that taxes were being paid.