Category Archives: Business Planning

The IRS, Employers, and the Trust Fund Recovery Penalty

Any person operating a business with employees should be aware of the Trust Fund Recovery Penalty that may be imposed by the Internal Revenue Service for the failure to collect and pay over the withholding taxes on an employee’s earnings. This penalty is imposed on the employer and any person who is responsible for collecting and paying over withholding taxes on the earnings of an employee and who willfully fails to do so. The amount of this penalty is equal to 100% of the amount of taxes that were not withheld and paid over to the IRS by the responsible individual. Payment to the government of the withheld taxes satisfies the penalty. The penalty is typically imposed on persons who fail to collect and pay over withholding on employee earnings and the FICA taxes (social security and medicare) and FUTA taxes (unemployment contributions) on those earnings.

When the employer and the responsible person willfully fail to collect and pay over to the IRS the withholding on earnings, the government suffers a loss because the employee gets credit for the tax withheld even though the employer does not pay the tax to the government. The withheld taxes are deemed held “in trust” for the benefit of the employee until paid over to the government; but when the employer and the responsible person fail to do so, for example, by diverting them to other uses, they are held personally liable for their payment.

The Trust Fund Recovery Penalty is not a penalty that is imposed over and above the withheld taxes, but is a device for ensuring the taxes are properly paid to the government. Without this device for ensuring the collection and payment of the taxes to the government, the responsible persons charged with collecting the taxes could be easily seduced into using the funds for unauthorized purposes.

An individual is a “responsible person” if he or she has a duty, whether spelled out in the by-laws of a corporation or in a partnership agreement or operating agreement in a limited liability company, or even based on the facts and circumstances of each case, to collect and pay over the taxes. It may even be a third party who supplies funds to the employer to pay employees and who has knowledge that the employer will not be withholding taxes on the wages. The test for responsible person status is not holding a title or office but whether the person has actual management and control over the finances of the employer, such as the ability to write checks and decide which of various creditors is to be paid with available funds. Mere awareness of the unpaid withholding taxes, without more, is not sufficient to satisfy the criteria of responsibility, which is based on the totality of circumstances. Courts typically have relied upon a multi-factored test, focusing on duty, status and authority, to evaluate whether one or more individuals are responsible persons.

Determining that a person is “responsible” is not enough to make that person liable for the penalty. The responsible person must have acted “willfully” in failing to collect and pay over the withholding taxes. Willfully means a deliberate, voluntary, conscious choice to prefer another creditor over the United States government. The IRS has defined willful as intentional, deliberate, voluntary, reckless, know-
ing, as opposed to accidental. No evil intent or bad motive is required. Mere negligence is not sufficient to show willfulness.

After the responsible person, as identified by the IRS, receives notice of the proposed penalty, he or she should file a protest with the IRS Appeals Office within 60 days of receiving the notice. If the responsible person files no protest within the 60 days, the IRS may commence collection action by levying on bank or brokerage accounts, etc.

In Appeals, the best defense against the Trust Fund Recovery Penalty is to show that someone else bears ultimate responsibility for the failure to withhold and pay over the taxes, provided, of course, that you have documentation establishing that fact. Another possible defense to the penalty is to determine whether the penalty was incorrectly calculated, which sometimes happens with the IRS. You may need access to the IRS file to present this defense. If the Appeals Office is convinced by these or other defenses, Appeals will recommend non-assertion of the penalty. If the responsible person is not successful in Appeals, he or she may still make an offer of settlement based on the strength of the case. If no settlement follows, the IRS will assess the penalty but the responsible person will have no access to the U.S. Tax Court because no statutory notice of deficiency is issued.

Alternatively, instead of filing a protest, the responsible person may pay part of the withholding tax and file a claim for refund to contest the penalty.

 
 

Essential Elements of Your Estate Plan Including Planning for Digital Assets

Why You Should Have a Will and Title Assets Properly. According to a recent survey, 60% of Americans do not have a will or an estate plan, a general durable power of attorney, or a living will. This can be disastrous and costly for loved ones who have to deal with the aftermath of one’s disability or death.

For example, if you die without a will in New Jersey, the laws of intestacy will determine how your assets will be distributed, which most likely will not be in a manner you would have preferred. Of course, any jointly-owned assets such as bank or brokerage accounts and real estate, and assets such as life insurance, IRAs, and pensions (such as 401(k) plan accounts) and other employee benefits, in which you designated a beneficiary upon your death, will pass by operation of law to those surviving joint owners or by contract to those designated beneficiaries. But other assets titled in your name alone will pass by intestacy. Even if you named one child as joint owner of your financial accounts, this will not fulfill your wish to distribute those accounts equally among all of your children, which can create dissension, unwanted litigation between family members, and unnecessary expenses and legal fees to the family. You should periodically review your joint accounts and your designations of beneficiary for life insurance, pensions, etc. to make sure they are in accord with how you want those assets distributed to your loved ones.

By meeting with an experienced estate attorney to help arrange your affairs, draft your will and create an estate plan in accord with your desires, you should be able to avoid the often costly and time consuming problems associated with dying without a will or with improperly designated accounts that may lead to family members contending with each other over how your asserts should have been distributed. Careful and thoughtful deliberation and planning with an estate planning attorney about your will and estate plan can save your family thousands of dollars in unnecessary litigation costs and legal fees.

What Happens to Your Digital Assets. “Digital assets” include all internet activities such as online accounts (Amazon.com, PayPal, online banking, business accounts, etc.) and usernames and passwords that provide access to those accounts so that your executor can properly manage and dispose of them after your death.

Planning for digital assets accomplishes several goals. First, upon your incapacity or death, your executor of your estate, your agent under your power of attorney, or your guardian, and family members will have to search for access to your digital assets unless you make it easy for them to readily locate that information without undertaking a massive search. Preparing and storing a list of your digital assets with the usernames and passwords in a safe deposit box or other secure location is paramount. To complicate things, the law is not clear regarding the rights to access the digital assets by executors, agents, guardians, and surviving family members. Some companies may require court orders before granting access to those individuals. In any event, you should still be prepared to make this information available in a secure manner to those acting on your behalf during your lifetime and after your death.

A second goal in planning for and securing your digital assets is to help prevent identity theft after your death. Upon your death your executor should immediately send notice of your death to the companies maintaining your digital assets so they can take the additional steps necessary to update their records to prevent criminals from gaining access to your accounts.
A third goal is to safeguard the financial assets of your estate.

A fourth goal is to prevent the disclosure of private or confidential material that you want to be kept secret.

Planning Ideas for Digital Assets After Your Death. First, some companies maintaining digital assets may provide instructions on their websites for what happens to those assets after your death. You should download and read those instructions carefully and ether take steps to follow those instructions or notify the company of how you want your information handled, if the company permits that. For example, Google has a service known as “Inactive Account Manager” that will notify individuals you designate, after a period of inactivity on your account, regarding what to do with your account information per the instructions you gave Google during your lifetime. Alternatively, you can instruct Google to delete all your information following this period of inactivity.

Second, you can store all of your digital asset information in a separate flash drive (encrypted) and keep it secure in a safe deposit box and update it when necessary. To ensure safety, usernames and passwords should be kept on separate flash drives and kept in different locations and given to different individuals. You can prepare a memorandum, which can be referenced in your will, indicating which beneficiary receives which digital asset. You can change the memorandum as often as you like without having to change your will. The last dated and signed memorandum will control the disposition of your digital assets. The list of the asset information on the flash drive and the memorandum will assist the executor in administrating your estate and will also be helpful to your family members.

On September 12, 2016, legislation was introduced in New Jersey to approve the Uniform Fiduciary Access to Digital Assets Act, which would authorize the executor or administrator to take control of online accounts. The legislation is still in progress.

Why You Should Have a Financial Power of Attorney. If you become physically or mentally incapacitated rendering you unable to handle your affairs, you will need someone to take care of your finances including managing your bank accounts and paying your bills, signing documents on your behalf, and having access to your digital assets. No one, including your spouse, may perform any of these tasks if you are incapacitated, and you do not have a general durable financial power of attorney. Not having one in place before you become mentally incapacitated will result in costly and time consuming guardianship proceedings for your loved ones to appoint someone, with court approval, to handle your financial affairs. Having a general durable financial power of attorney in place can avoid this from happening. It is the simplest and least expensive estate planning tool available and should be part of everyone’s basic estate plan. Another consideration to plan for is to determine whether you will have sufficient financial resources to replace your income in the event that your disability renders you unable to work, which brings up the importance of disability insurance that you should discuss with your insurance agent.

Why You Should Have a Health Care Directive and Living Will. Appointing someone to make health care decisions for you in the event you are mentally incapacitated and cannot make them yourself is also an important estate planning tool. This is known as a health care directive or proxy directive. You only name the person to make those decisions but you do not specify your health care instructions. That is done in the Living Will, which states how you would want to be treated in certain health care situations. Both the proxy directive and the living will can be combined in one document known as an Advanced Medical Directive and Living Will. You can specify whether and what kind of extraordinary medical procedures should be taken for you in certain health care situations.

Hiring an estate planning attorney to guide you and prepare and implement the essential elements of an estate plan for you and your family should go hand in hand with your other family financial planning to preserve and protect your assets for future generations.

Please email (dhaase@dmhaaselaw.com) or call (973-744-0073) Dennis M. Haase, Esq. in Montclair, New Jersey for an appointment to discuss your tax, estate planning, or estate administration needs.

 
 

Why Your LLC Needs a Written Operating Agreement

The New Jersey Revised Uniform Limited Liability Company Act (the “Revised LLC Act”) took effect on March 18, 2013 for LLCs formed on or after that date and on April 1, 2014 for all other New Jersey LLCs. The Revised LLC Act repealed the old New Jersey LLC Act and now provides, among other things, that an operating agreement may be in writing, oral, or implied from the facts and circumstances of how the LLC operates.

Although the Revised LLC Act permits oral or implied operating agreements, common sense and sound business judgment compel the need for your LLC to have a written operating agreement. An operating agreement is the equivalent of a partnership agreement for a partnership. Like partnership agreements, operating agreements can have varying levels of complexity covering activities ranging from a two-person auto body shop to multi-million dollar ventures. The operating agreement functions as the heart and soul of the LLC, and issues concerning members’ sharing of profits and losses, timing and sharing of distributions to members, transfer of LLC interests, rights of withdrawing members, and other organic changes to the LLC, which are critical to its continuing existence and prosperity, should be spelled out in writing.

Over time, memories fade and disputes may arise, for example, over what a withdrawing or resigning member is entitled to receive as fair compensation for his or her LLC interest after departing the LLC or what circumstances may constitute “good cause” to force one member out of the LLC. These and other issues, if not spelled out and reduced to writing in a well structured and crafted written operating agreement, will be decided by default under the provisions of the Revised LLC Act or, after litigation erupts, implied from the circumstances of how the LLC in fact has operated, or not covered at all, which may lead to disappointment, the financial detriment to one or more members, or the court-ordered dissolution of the LLC.

Disputing an oral operating agreement only serves to enrich the trial attorneys and proving the existence of such an agreement may well be insurmountable. For example, suppose A and B form the Acme LLC and you contribute thousands of dollars to Acme and help generate revenue for Acme. You believe that you are a member of the LLC but you have nothing in writing to confirm this. Subsequently, A and B transfer Acme’s assets to a company solely owned by A and B. You decide to sue for breach of contract and breach of fiduciary duty. The court rules that your oral “agreement” is unenforceable because all the material terms of the agreement were never discussed or finalized. At best, you are only able to show that an agreement was discussed and that the essential terms would be worked out later. Your suit fails because it was not enough to prove breach of contract or fiduciary duty.

Relying on the default provisions of the Revised LLC Act may not be appropriate either. For example, the Revised LLC Act provides that unless the members of an LLC otherwise agree, all distributions of profits shall be shared equally between members. This means that even if one member (A) contributes $90,000 and the other member (B) contributes $10,000 at formation of the LLC, they will equally share in the profits of the LLC. To avoid this result and any potential disputes, A and B should reduce to writing their agreement that they share distributions of profits in proportion to their respective contributions. In the example given, the operating agreement would expressly state that A would receive 90% and B would receive 10% of distributions of profits and losses, subject to any further changes in their respective ownership percentages of the LLC.

By having in place a well structured and crafted written operating agreement, you should avoid much confusion, misunderstanding, and waste of time and resources in operating your LLC and have the freedom to concentrate on maximizing the potential of your business.

Dennis M. Haase, Esq. has thirty years’ tax and business experience in drafting business and commercial agreements for closely-held and family business organizations and handling tax controversies with the IRS and various states. You may call (973-744-0073) or email (dhaase@dmhaaselaw.com) him to schedule an appointment to discuss your tax, business planning, estate planning needs, and solutions to your tax controversies.