DOJ Repeatedly Signals Intent to Ramp Up Criminal Prosecutions for Employment Tax Failures

The U.S. Department of Justice has recently proposed amendments to the U.S. Sentencing Commission Guidelines Manual (the “Guidelines”) to sharpen criminal prosecution of willful tax violations. Code section 7202 provides that any person who willfully fails to collect or truthfully account for and pay taxes when required shall be guilty of a felony and, if convicted, subject to a fine up to $10,000 and up to five years’ imprisonment. Since 1987, the background commentary in the sentencing guidelines has stated that Code section 7202 violations are “infrequently prosecuted.” In its annual letter to the Sentencing Commission, the Justice Department explained that defense attorneys have been citing this language to argue for more lenient sentences in Code section 7202 cases. The Justice Department recommended that the sentence be deleted because it is no longer true: Prosecutions have grown from three cases in 2002 to 46 cases in 2014. The Sentencing Commission subsequently recommended that the Guidelines be amended to delete the sentence as a requested.

At a Federal Bar Association Tax Law Conference on March 4, 2016, two attorneys from the Justice Department confirmed that the proposed change reflects the Justice Department’s commitment to employment tax enforcement and is dedicating additional resources to Code section 7202 cases. Employment tax withholdings represent 70 percent of all revenue collected by the Internal Revenue Service, and rampant violations are prompting the U.S. Department of Justice to prosecute employment tax violations more aggressively. Speaking at the Federal Bar Association Tax Law Conference on March 4, 2016, Caroline. D. Ciraolo, the Department of Justice Tax Division Acting Assistant Attorney General, said that the Justice Department will seek more civil injunctions in employment tax cases, which involve employers who fail to collect, account for, and deposit employment wage withholdings. Employers subject to a civil injunction must pay employment taxes on time, notify the IRS when the taxes have been paid, refrain from assigning property to or paying creditors until the taxpayers have paid employment tax obligations accruing after the date of the injunction, and inform the IRS if they establish a new business.

More recently, Noreene Stehlik, a recently appointed Senior Litigation Counsel at the Department of Justice Tax Division, also affirmed the Justice Department’s commitment to employment tax enforcement. At a D.C. Bar Taxation Section conference on April 13, 2016, Stehlik stated that the Justice Department has, in the first quarter of 2016, sought almost as many civil injunctions as it sought in all of 2015. She added that employers not complying with civil injunctions may be subject to criminal prosecution.

The Justice Department’s more aggressive approach seems to embrace the idea that when an employer, payor, or withholding agent makes the decision to use trust fund taxes (i.e., taxes withheld from employees, taxes withheld for backup withholding purposes, and taxes withheld under Chapters 3 and 4 of the Code) to pay other creditors, the use of such funds is tantamount to theft. Businesses that engage in this practice tend to be in dire straits financially and should not make matters worse by using funds held in trust for the government. Engaging in such practices often leads to personal liability for the individuals approving or making the decisions to improperly use the funds, but may also lead to criminal prosecution based upon recent comments from the Justice Department.

Court Allows Foreclosure of Delinquent Taxpayer’s Home and Business Property for Employment Tax Liability

The U.S. District Court for the District of New Mexico recently held that the government is entitled to foreclose federal tax liens against a delinquent taxpayer’s home and business property, even though the taxpayer’s wife may be a joint owner. In United States v. Fields, Samuel Fields, the sole proprietor of a dry cleaner business, owed $211,855.80 in employment and unemployment taxes from 1993 to 2009. The IRS had made assessments against Fields starting in 1995. In 2005, for no consideration, Fields executed deeds to his two real properties – his home residence and business property – located in New Mexico, stating that he and his wife were joint owners. The U.S. Department of Justice sought partial summary judgment against Fields personally and to foreclose its federal tax liens against his home and business property.

The key issue was whether the federal tax liens were superior to the wife’s interests in the properties. Under Internal Revenue Code Sections 6321 and 6322, if a person fails to pay federal taxes owed, on the day the taxes are assessed a statutory tax lien arises and attaches to all property rights owned by the person. Further, the tax liens will also defeat a third party’s interest in the property unless that third party is a certain secured interest holder, a judgment lien creditor, or a purchaser. While priority of federal tax liens is determined by federal law, property interests are determined under state law – New Mexico law, in this case.

The court held that the tax liens arising from assessments made before Fields executed the deeds encumber and are superior to the property interests of both Fields and his wife. But the tax liens arising from assessments made after Fields executed the deeds, as a matter of law, only encumber and are superior to Fields’ interests in half of the value of each property. Although the United States may ultimately be entitled to the full value of each property if the deeds were a fraudulent transfer under New Mexico law, this issue may involve a factual determination as to Fields’ intent, and so the United States did not include it in its motion for partial summary judgment. Thus, the court permitted the foreclosure, as Section 7403(c) allows district courts to order the sale of property subject to a federal tax lien regardless of homestead exemptions or other ownership interests.

This case is part of the U.S. Department of Justice’s commitment to cracking down on employment tax violations.