Once again, the IRS has successfully secured the conviction of a business owner who willfully failed to pay over payroll taxes withheld from his employees. In Crabbe v. United States, No. 08-1393, 2010 U.S. App. LEXIS 1931 (10th Cir. Jan. 28, 2010), the U.S. Court of Appeals for the 10th Circuit affirmed the conviction and 37-month sentence of the business owner.
Payroll taxes withheld from employee paychecks are the property of the U.S. government, and are held in trust by employers until such time as they are deposited with the government. If a business fails to deposit payroll taxes, the IRS will seek to recoup them from any “responsible person” of the employer, including officers, directors, owners, or bookkeepers with signature authority over a bank account. The personal liability of such individuals can be substantial, and can include criminal liability under § 7202 of the Internal Revenue Code for “willful” failures to “collect, account for, and pay over” payroll taxes.
In the past, criminal prosecutions under § 7202 were fairly rare, and the IRS was content to seek civil penalties against violators. However, in 2008, the IRS secured the conviction and 30-month sentence of a business owner who failed to pay over a portion of the payroll taxes he collected from his employees to the IRS, because he claimed he needed to money to meet the operating expenses of his business. See United States v. Easterday, 539 F.3d 1176 (9th Cir. 2008) and “Failure to Pay Over Payroll Taxes Could Land You in Jail.” As the conviction in Crabbe makes clear, the IRS’ use of its prosecutorial powers in Easterday for such violations was no fluke, and business owners need to ensure they are properly remitting payroll taxes to the government.
In Crabbe, the business owner was the vice president of a business that provided nursing services to healthcare facilities. He had no defined duties and was not responsible for the day-to-day management of the company. The business operated by contracting with nurses willing to provide short-term services, and matching them with facilities that had contracted with the business for such services. In doing so, the nurses signed contracts with the business that stated they were employees of the business, that the business was responsible for withholding all applicable payroll taxes, and that it would issue them W-2s for their wages.
In 1999, Crabbe learned that his partner had failed to pay over payroll taxes to the government. He convinced the president to retain a tax attorney who advised the business to stay up to date with its payroll tax obligations and resolve its deficiencies as best it could. For a short time thereafter, the company regularly paid over its payroll taxes, but by the end of 1999, it had fallen behind again.
In 2000, Crabbe unilaterally opened a bank account on his own through which he intended to pay the company’s taxes. In 2001, Crabbe convinced the president to allow him to prepare the company’s delinquent quarterly payroll tax returns that spanned from the first quarter of 1999 to the first quarter of 2001. Crabbe filed them himself, after using the company’s payroll software to prepare the delinquent returns (i.e., Forms 990). On each of these forms, Crabbe only counted and paid over the taxes withheld for the business’ corporate employees, and did not include any of its nurses in the payroll tax deposits made to the government.
In October 2002, Crabbe was informed that he had failed to file returns for the company’s nurses from whom the company had withheld federal taxes, and that he had misrepresented the number of employees on some of the returns he had filed. Although he asked how to remedy these misrepresentations, and another employee began preparing correct and complete returns, Crabbe took no further action at that time.
In 2003, the IRS became aware of the issue, and by 2004, it had opened a criminal investigation into the company and its officers. In August 2004, after being informed of the criminal investigation, Crabbe remedied his previously deficient filings by completing new tax returns and paying over all the payroll taxes withheld from his staff. Nonetheless, Crabbe was convicted of 30 violations of the federal tax laws and received a 37-month prison sentence.
On appeal, the 10th Circuit affirmed Crabbe’s conviction. The court rejected, among other things, Crabbe’s claim that the nurses were independent contractors and not employees, noting specifically that the business had the power to control the method and manner in which they worked, had contracted with the nurses to pay them wages, withheld payroll taxes, and issued W-2s.
The court further held that Crabbe was a “responsible person” pursuant to § 7202 because he was a corporate officer, had the authority to distribute funds, had a large ownership interest in the company, and had fired at least one employee in the past. Most importantly, however, the court held that Crabbe’s violations of the tax laws were willful, despite his efforts to remedy the company’s deficiencies, because he was aware of his duties, intentionally failed to pay over the payroll taxes withheld from the nursing staff, and failed to fully remedy the problems until he was already the subject of a criminal investigation.
Crabbe and Easterday underscore the importance of paying over payroll taxes owed to the government. Moreover, they show that remedying past violations may not be adequate to avoid criminal prosecution. Thus, employers, and more specifically their principals, must be sure to completely pay over their collected payroll taxes in a timely fashion or face prosecution.