Brieden, Sarah S.

English

Southern Methodist University

SMU Law ReviewVolume 56 | Issue 1 Article 262003The Ninth Circuit Holds That an Employer'sFinancial Difficulties Can Constitute ReasonableCause for Failure to Pay Employment Taxes - VanCamp & (and) Bennion, P.S. v. United StatesSarah S. BriedenFollow this and additional works at: https://scholar.smu.edu/smulrThis Case Note is brought to you for free and open access by the Law Journals at SMU Scholar. It has been accepted for inclusion in SMU Law Reviewby an authorized administrator of SMU Scholar. For more information, please visit http://digitalrepository.smu.edu.Recommended CitationSarah S. Brieden, The Ninth Circuit Holds That an Employer's Financial Difficulties Can Constitute Reasonable Cause for Failure to PayEmployment Taxes - Van Camp & (and) Bennion, P.S. v. United States, 56 SMU L. Rev. 749 (2003)https://scholar.smu.edu/smulr/vol56/iss1/26THE NINTH CIRCUIT HOLDS THAT ANEMPLOYER'S FINANCIAL DIFFICULTIESCAN CONSTITUTE REASONABLE CAUSEFOR FAILURE TO PAY EMPLOYMENTTAXES- VAN CAMP & BENNION,P.S. V. UNITED STATESSarah S. Brieden*HE Courts of Appeals have differed in determining whether a tax-payer's financial difficulties can constitute "reasonable cause" suf-ficient to waive the penalty, required by the Internal RevenueCode, for failure to pay employment taxes.1 The Sixth Circuit, in Brew-ery v. United States,2 established the rule that financial difficulties cannot,as a matter of law, constitute reasonable cause for failure to pay both thetrust fund and the non-trust fund portions of employment taxes. 3 TheSecond 4 and Third 5 Circuits have rejected Brewery's rule. Most recently,in Van Camp & Bennion, P.S. v. United States,6 the Ninth Circuit joinedthe Second and Third Circuits in rejecting the Brewery rule, holding thatfinancial difficulties can constitute reasonable cause for failure to pay em-ployment taxes.7 The court stated that following the Sixth Circuit's rea-soning would effectively do away with the reasonable cause exception topenalties. 8 By rejecting the Brewery rule, the court failed to consider twopoints: (1) a portion of the employment taxes were withheld from em-* Candidate for J.D., Southern Methodist University Dedman School of Law, 2003;M.S., Texas A&M University, 2000; B.B.A, summa cum laude, Texas A&M University,2000.1. The Internal Revenue Code sections that deal with penalties for failure to pay taxand failure to make deposits both require an addition to the tax owed "unless it is shownthat such failure is due to reasonable cause and not due to willful neglect." 26 U.S.C.§ 6651 (1989 & Supp. 2001) (failure to file tax return or to pay tax) and 26 U.S.C. § 6656(1989 & Supp. 2001) (failure to make deposit of taxes). For a discussion of what is consid-ered reasonable cause, see Joyce L. Sugawara et al., Defining Reasonableness Before theInternal Revenue Service, L.A. LAW., May 2000.2. Brewery v. United States, 33 F.3d 589 (6th Cir. 1994).3. Id. at 592-94.4. Fran Corp. v. United States, 164 F.3d 814, 818 (2d Cir. 1999).5. East Wind Indus., Inc. v. United States, 196 F.3d 499, 508 (3d Cir. 1999).6. Van Camp & Bennion, P.S. v. United States, 251 F.3d 862 (9th Cir. 2001).7. Id. at 869.8. Id.SMU LAW REVIEWployees' paychecks and technically held in trust for the government, and(2) factors other than financial difficulties can constitute reasonablecause, 9 and therefore, the reasonable cause exception is still available totaxpayers without considering financial difficulties.Walter R. Van Camp and Irving R. Bennion, both attorneys, owned60% and 40%, respectively, of the professional services corporation VanCamp & Bennion, P.S. ("the Corporation").' 0 Van Camp served as theCorporation's president and Bennion was the vice president and secre-tary-treasurer. 1Van Camp, a specialist in personal injury, attracted clients to the firm' 2and performed the vast majority of the legal services provided by theCorporation. 13 On the other hand, Bennion's involvement with the Cor-poration was limited and he carried a reduced case load. 14 Because 99%of Van Camp's fees came from contingent fee agreements, the Corpora-tion's income and cash flows were irregular.15The Corporation suffered financial difficulties in 1989.16 Van Camp ex-perienced serious personal problems, which included long-term hospital-izations, depression, divorce, personal bankruptcy, and the loss of severalassociates of the firm.17 These personal problems negatively affected VanCamp's ability to provide legal services to his clients.' 8 They also resultedin the Corporation's insolvency from 1989 to 1991.19 Because of limitedcash flow, the Corporation failed to pay employment taxes in 1989 and1991.20After an IRS audit, the Corporation paid $34,000 in withholding andsocial security taxes, interest, and penalties that the Corporation failed topay in 1989 and 1991.21 The IRS rejected a timely-filed claim for a refundof this payment.22 The Corporation then filed a complaint in federalcourt for a refund of the payment. 23 This case was consolidated with asecond complaint seeking a refund of other taxes, interest, and penalties9. See United States v. Boyle, 469 U.S. 241, 243 n.1 (1985). The IRS has given eightreasons for late filing that it considers reasonable cause. Id. (citing Internal Revenue Man-ual (CCH) § 4350, (24) 22.2(2) (Mar. 20, 1980)).10. Van Camp, 251 F.3d at 864.11. Id.12. Id.13. Van Camp & Bennion, P.S. v. United States, No. CS-94-409-CI, 1996 WL 529225,at *2-3 (E.D. Wash. July 17, 1996).14. Id. at *3.15. Id. at *2.16. Id. at *1.17. Id. at *6.18. Van Camp & Bennion, 1996 WL 529225, at *6.19. Id.20. Van Camp, 251 F.3d at 864.21. Van Camp & Bennion, 1996 WL 529225, at *1.22. Id.23. Id. The original complaint was filed in the Western District of Washington, butwas transferred to the Eastern District of Washington.[Vol. 56CASENOTErelating to the wages paid to Van Camp and Bennion.24 In its complaints,the Corporation claimed, in part, that the penalties paid on the taxesshould be abated because financial difficulties experienced by the Corpo-ration constituted reasonable cause to excuse the failure to pay thetaxes. 25Following the Brewery rule, the district court concluded that the Cor-poration's financial problems 26 did not, as a matter of law, constitute rea-sonable cause for failure to pay employment taxes.27 The Ninth Circuitrejected the reasoning in Brewery holding that financial difficulties mayconstitute reasonable cause.28 The court reversed the district court's rul-ing and remanded the case for a determination of whether the Corpora-tion's problems actually were reasonable cause.29Writing for the Ninth Circuit, Judge Beezer considered the Corpora-tion's assertion that penalties were not due on the unpaid employmenttaxes. 30 He noted that the Sixth Circuit3' disagreed with the Second 32and Third33 Circuits on whether financial difficulties of the taxpayer cor-poration excuse nonpayment of employment taxes.34 In this case of firstimpression for the Ninth Circuit,35 Judge Beezer considered the conflict-ing reasoning of the courts that previously decided this issue to determineif financial difficulties can constitute reasonable cause for failure to payemployment taxes.36The court concluded that financial difficulties of the taxpayer corpora-tion may constitute reasonable cause for failure to pay employment taxesand determined that the penalties for failure to pay may be excused. 37The Ninth Circuit, in so holding, agreed with the Fran Corp. v. UnitedStates and East Wind Industries, Inc. v. United States decisions and re-jected the "bright line rule" of the Brewery case that financial difficulties24. Id. The IRS assessed a deficiency against the corporation for failure to pay em-ployment taxes with respect to wages paid to Bennion and Van Camp. Van Camp, 251 F.3dat 864. The Corporation asserted that the attorneys were not employees of the corpora-tion, but were independent contractors, and therefore the corporation was not responsiblefor employment taxes for these wages. Id. On this issue, the Ninth Circuit affirmed thedistrict court's ruling that Van Camp was an employee of the firm while Bennion was anindependent contractor. Id. at 865.25. Van Camp, 251 F.3d at 866.26. As part of its factual findings, the district court concluded that Van Camp's testi-mony about the personal problems he experienced was credible. Van Camp, 251 F.3d at867. The court further concluded that the problems faced by Van Camp placed sufficientfinancial stress on the Corporation to put its survival in question. Id. at 868.27. Id.28. Id. at 867.29. Id.30. Id. at 866-67.31. Brewery, 33 F.3d at 592-94.32. Fran, 164 F.3d at 816-18.33. East Wind, 196 F.3d at 504-08.34. Van Camp, 251 F.3d at 867.35. Id.36. ld. at 866-67.37. Id. at 868.20031SMU LAW REVIEWcannot, as a matter of law, constitute reasonable cause.38 As part of itsanalysis, the court said, "If the potential ruin of a corporation is not rele-vant, then the reasonable cause exception is virtually meaningless. '39Citing the Third Circuit's opinion in East Wind, the court noted thatTreasury Regulations40 require the court to look at the taxpayer's finan-cial situation when determining if the taxpayer had reasonable cause forfailure to pay taxes.41 The court found that the facts in this case illus-trated the need to reject the Sixth Circuit's reasoning because the per-sonal and financial difficulties of Van Camp put the survival of thecompany in jeopardy.42The Van Camp court should have affirmed the district court's ruling, atleast with respect to the trust fund portion of the tax liability. The Brew-ery court was correct in finding that financial difficulties cannot constitutereasonable cause. The Sixth Circuit's reasoning is correct because thewithheld tax money is held in trust for the U.S. government and not re-mitting the tax when it is due is equivalent to making the government "anunwilling partner in a floundering business."'43 The money withheld fromemployee paychecks does not technically belong to the company and thecourts should not allow business to use this money for operatingexpenses.The Van Camp court fails to consider the language of the TreasuryRegulations, which seem to differentiate between the failure to pay with-holding taxes and the same act with regard to other taxes. The regula-tions state, "facts and circumstances which, because of the taxpayer'sefforts to conserve assets in marketable form, may constitute reasonablecause for nonpayment of income taxes may not constitute reasonablecause for failure to pay over taxes described in § 7501 that are collectedor withheld from any other person. ' 44 This regulation places a heavierburden on an employer who fails to pay over withheld taxes. Because themonies withheld from employees do not technically belong to the em-ployer, it is reasonable to conclude that the employer has no claim tothose funds and no right to use them for operating expenses.The Van Camp court committed its second error by concluding that thedisallowance of financial difficulties as reasonable cause would "effec-tively read out of the statute the 'reasonable cause' exception to themandatory penalties in many employment tax cases."'45 This conclusionseems to ignore a point made earlier in its own opinion that the IRS has38. Van Camp, 251 F.3d at 868.39. Id.40. Treas. Reg. § 301.6651-1(c)(1) (2000).41. Van Camp, 251 F.3d at 867.42. Id. at 868.43. Brewery, 33 F.3d at 593 (citing Thibodeau v. United States, 828 F.2d 1499, 1506(11th Cir. 1987)).44. Treas. Reg. § 301.6651-1(c)(2).45. Van Camp, 251 F.3d at 868 (quoting Fran, 164 F.3d at 819).[Vol. 56CASENOTEgiven eight circumstances that constitute reasonable cause. 46 The courtdiscounts these circumstances by stating that consideration of financialdifficulties is necessary for reasonable cause to exist in the context of em-ployment tax. This contradicts the court's own opinion because justbefore its discussion of financial problems, the court found that the dis-trict court's "failure to examine whether Van Camp's illness was seriousenough to establish reasonable cause was clearly erroneous. '4 7 By itsown admission, even this case proves that in the employment tax context,reasonable cause can exist without consideration of financial difficulties.When considering the non-trust fund portion of employment taxes, theargument in favor of the bright-line rule of Brewery is not nearly asstrong, and the logic of Van Camp seems more reasonable. With this por-tion of the taxes, the government is essentially in line for payment alongwith all of the employer's other creditors. This tax is not one that theemployer is required to pay on behalf of someone else, but is simply an-other debt of the employer. The Brewery court concluded that the ruleshould be the same for both portions of the tax.4 The court reached thisconclusion because the tax is for the employees' benefit and becauseeconomists have concluded that employees bear the cost of the em-ployer's share of employment tax in the form of lower wages.49 On thisissue, the court's reasoning is not as persuasive as it is with the trust fundportion of the tax. First, the United State's tax definition of income doesnot always follow the economic definition. Therefore, economists' con-clusions should hold little weight in tax law. Secondly, these paymentsare made out of the employer's operating funds. Because these fundsbelong completely to the employer, it is reasonable to conclude that aprudent businessman may logically choose to pay rent or an electric billbefore a tax bill when funds are low and a choice must be made.As evidenced by the split in the courts, there are supportable argu-ments on both sides of the issue of whether financial difficulties may con-stitute reasonable cause. Because it ignored the trust fund properties ofwithholding tax, the Van Camp court mistakingly concluded that the em-ployer's financial strain can constitute reasonable cause. Van Camp'slogic, however, is quite persuasive when considering an employer's failureto pay its own share of employment taxes. Judges dealing with this issueshould look at these portions of the tax separately. Penalties for the non-46. Id. at 867. The court cites Boyle, 469 U.S. at 243-44 n.1. The Boyle court lists eightcircumstances that constitute reasonable cause in failing to file a return, they include "una-voidable postal delays," "the taxpayer's reliance on the erroneous advice of an IRS officeror employee, the death or serious illness of the taxpayer or a member of his immediatefamily, the taxpayer's unavoidable absence, [and] destruction by casualty of the taxpayer'srecords or place of business" (citing Internal Revenue Manual (CCH) § 4350, (24)22.2(2)). See also Defining Reasonableness Before the Internal Revenue Service, whichidentifies other events that may constitute reasonable cause, including an electronic fundstransfer that is delayed by the financial institution. Id. at 24 (citing Rev. Rul. 94-46, 1994-2C.B. 278).47. Van Camp, 251 F.3d at 867.48. Brewery, 33 F.3d at 593-94.49. Id.2003]754 SMU LAW REVIEW [Vol. 56payment of the trust fund portion should never be excused because offinancial difficulties. However, the rule for the employer's portion of em-ployment taxes should not be so harsh and should allow a considerationof the financial standing of the employer.Tributettl$OD~sROBERT H. DEDMAN, SR.1~ ODI~D 4LS LA~

The Ninth Circuit Holds That an Employer\u27s Financial Difficulties Can Constitute Reasonable Cause for Failure to Pay Employment Taxes - Van Camp & (and) Bennion, P.S. v. United States

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The Ninth Circuit Holds That an Employer\u27s Financial Difficulties Can Constitute Reasonable Cause for Failure to Pay Employment Taxes - Van Camp & (and) Bennion, P.S. v. United States

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