A recent Texas federal district court case serves as a reminder to all physician practice managers. The ruling found that an individual who manages a physician practice can be personally responsible for the "employee portion" of unpaid employment and payroll taxes of the practice, even if the practice manager is not an owner of the practice.
In McClendon v. U.S., 124 AFTR 2d ¶2019-53 (DC TX 1/22/19), the District Court agreed with the IRS’s request to hold Richard T. Stephen Jr., the former CFO and practice manager of a physician practice, personally responsible for significant tax liability. The total amount of liability that Stephen was responsible for was more than $4.3 million of $11 million in unpaid employee payroll taxes the practice had accumulated over a period of five years.
By statute, the IRS can impose personal responsibility on any individual who exercises control or can control an entity with unpaid employee payroll and employment taxes that have been deducted from employee paychecks but not remitted to the government if the individual “willfully fails to . . . pay over such tax” to the IRS. (See Internal Revenue Code (IRC) Section 6672).
The rationale for this statute is that employers that deduct federal Social Security, Medicare and income taxes from employees’ earnings must hold these funds “in trust” for the government and must remit these funds to the IRS in a timely manner. The employer should not use these withheld funds to pay other operating expenses such as payments to vendors, lenders, landlords and other creditors.
In situations in which the entity — in McClendon, a professional medical association — does not remit employee payroll taxes, the IRS will typically use IRC Section 6672 to impose personal responsibility, called the Trust Fund Recovery Penalty (TFRP), on any employee or officer of the entity who is under a duty to collect, account for and pay these taxes. The TFRP penalty amount is the amount of tax collected by the entity but not paid to the IRS.
However, to impose personal liability, the government must prove that the individual against whom this liability is asserted is a “responsible person” and “willfully” failed to pay the taxes. These two requirements can be proven by a review of the duties and status of the individual to the entity with the unpaid taxes, to determine if the individual had the effective power to pay the taxes. Willfulness can be shown by proof that the individual knew of the obligation to pay payroll taxes but decided to pay other operating expenses instead.
In McClendon, the IRS asserted that Stephen had served as the practice entity’s CFO for almost 15 years, managed the practice's daily operations and finances, had hiring/firing authority, paid creditors, determined the order of payment of creditors, was an authorized signatory on the practice’s bank accounts and was responsible for payroll and for filing payroll tax returns. Because Stephen did not dispute the statements of facts by the government and did not submit any information to dispute the facts as true, he was not able to rebut the legal presumption that the IRS' allegations were correct.
Thus, the district judge found that as a matter of law, Stephen was a “responsible person” under IRC Section 6672 and that he had willfully failed to remit employee payroll taxes, since as a result of his actions, the practice paid creditors other than the IRS while payroll taxes were owed to the IRS.
Physician practice managers should take note that they must make certain that the practice pays its payroll taxes in a timely manner before it pays other creditors, particularly wages and bonuses to physician owners. In situations in which the physician owners refuse to allow the practice managers to pay payroll taxes in a timely manner, practice manager should, at a minimum, confirm in writing to the physician owners that he/she has specifically directed the manager to favor other creditors. Depending on the amount of the unpaid payroll taxes and the number of tax periods the payroll taxes are delinquent, the practice manager should also consider resigning.
As a footnote to the McClendon decision: Some five years after the last year that the practice’s payroll taxes were not paid, Stephen pled guilty in Texas state court to criminal charges based on his embezzlement of money from his former employer. This, of course, explains why Stephen chose not to resign from serving as manager of the physician practice.
Ralph Levy, JD, LL.M. in Taxation, is a member partner in the Health Care practice at Dickinson Wright. He assists and advises entrepreneurs and owners of closely-held businesses in operationalizing their business plans, including the estate planning, business succession and tax planning issues thereof. Ralph has more than 40 years of experience in counseling clients in the healthcare area.