The Case of Substance Abuse and a Tax Nightmare

Issue: A company is experiencing financial difficulties and stops meeting its employment tax withholding obligations. Both the company’s president (who is also the owner) as well as the CFO are aware of the company’s failure to pay over withholding taxes to the IRS. Throughout this period, the company’s president has been addicted to cocaine and alcohol. The IRS eventually files suit against both the president and the CFO seeking payment of the unpaid taxes and imposes the 100% “responsible person” penalty under IRC §6672 on both individuals. Does the company president’s drug and alcohol addiction absolve him of liability for the 100% “responsible person” penalty?

Answer: The company president is still liable. In order to be liable for the penalty, the individual must be a “responsible person”—someone with significant control over an entity’s finances—and must willfully fail to pay over the taxes. Voluntary intoxication, including drug or alcohol addiction, may never serve as a defense to the “responsible person” penalty.

When this case was appealed to the U.S. Court of Appeals, the court rejected the president’s argument that his drug addiction prevented him from acting willfully when he failed to pay over the taxes. The court noted evidence suggesting that the president was aware of the company’s failure to pay over the taxes and that the president maintained ultimate authority over the company’s financial affairs during the course of his addiction. Factors that indicate significant control over finances include:

1. supervisory authority over an employer’s financial affairs,
2. authority to determine the order in which creditors are paid, and
3. control over payment of wages.

However, the CFO might be off the hook. He argued that despite the existence of corporate documents clearly giving him the authority to pay over the taxes, he had no actual authority to do so given the instructions he received from the company president to pay trade creditors before the employment taxes. The court agreed that, in theory, such a situation could exist, but the CFO would be required to prove that reality did not match the documentary evidence.

Cite: U.S. v. Landau, CA-2, 155 F.3d 93 (1998), cert. denied 119 S.Ct. 1803 (1999).

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