Over the past 10-15 years, the Department of Justice Tax Division has become much more aggressive about bringing injunction actions against taxpayers who fail to pay their employment taxes over an extended period of time. The IRS calls the repeated failure to pay employment taxes “pyramiding” and views this as one of the most serious types of bad tax behavior, following such other types of bad behavior as evasion and tax shelter promotion. While the IRS has a long history of prosecuting tax evasion and a pretty solid record of getting legislation to root out and aggressively pursuing tax shelter promoters, it has suffered for a long time with the issue of how to stop pyramiding. We are adding some material on injunctions to Chapter 14 of Saltzman and Book, IRS Practice and Procedure which led us to pay more careful attention to the recent cases coming out on this issue. As you will see from the discussion below, the rules governing the enjoining of taxpayers from continuing a business have not been uniformly developed and applied.
The most recent former Acting Assistant Attorney General in charge of the Tax Division, Caroline Ciraolo, made it one of her signature enforcement efforts to prosecute and/or enjoin taxpayers who engaged in pyramiding. Some of the DOJ press releases on this effort provide a flavor for what they have done in this area: general discussion; injunction in Texas; injunction in Pennsylvania; injunction in Iowa; and injunction in New York. Prosecution has long been a desired effort by the folks in collection at the IRS, and I am sure they were delighted with this effort. The civil action that parallels prosecution for failure to pay employment taxes is an injunction action. Like prosecution, this is a labor intensive effort both on the part of the IRS and DOJ. A pair of cases this summer tell some of the story of the effort to root out pyramiding through suits to enjoin the taxpayers engaged in the activity. Usually, these types of suits are coupled with other actions such as reducing the liability to judgment and foreclosing the tax lien on some property.
Under the general authority granted by Section 7402(a), the Service can bring an injunction action in certain circumstances in order to stop a taxpayer from taking or continuing certain actions. The Service uses its injunctive authority, and this is authority that it uses sparingly, to seek to stop taxpayers from pyramiding employment taxes in circumstances in which the taxpayer has demonstrated a long term pattern of failing to pay employment taxes. Courts have not provided clear guidance on exactly what the Service must show in order to obtain injunctive relief. Because granting injunctive relief will generally result in the taxpayer losing the right to engage in business, courts carefully look at the request. While seeking criminal prosecution against the responsible officer(s) of a business that has a long history of pyramiding employment taxes provides an alternative to seeking injunctive relief to stop a business from operating and continuing to pyramid, each type of relief places a high burden of proof on the Service as well as a high cost in time and effort.
In United States v. Padron, the court granted injunctive relief in a decision entered in May, 2017. In the Padron case, the Service brought suit against both the individual responsible for running the business and the business itself. The defendants did not vigorously defend the action. The business defaulted and the individual agreed to enter into a consent judgment that included the injunction. Nonetheless, the court saw the need to carefully review the case in order to determine if injunctive action was appropriate including whether the claim of the Service for injunctive relief had merit. The court found the claim for injunctive relief had merit only after looking at the standard it should apply, and noting that the 5th Circuit had not ruled on the issue.
The court stated that the issue of what constitutes a sufficient basis for a permanent injunction under Section 7402(a) has created a split in authority among the courts that have addressed it. Some courts require the Service to show the traditional factors for use of the equitable remedy of injunction. As we discuss in more detail in the Saltzman chapter, the majority of courts permit an injunction under Section 7402(a) if the government shows “that an injunction is appropriate for the enforcement of the internal revenue laws, without reference to the traditional equitable factors.” Having determined that it had a sufficient basis for entering a permanent injunction against the business, the court had little trouble finding that it had a basis for entering one against the individual responsible officer of the business.
Reflecting the split of authority on the issue, in US v Moore, the district court in New Jersey reached the opposite conclusion, a case in which the taxpayer did not contest the imposition of an injunction. The Service sought a default judgment, including an injunction against a taxpayer running a dental practice. The principal of the business failed to pay employment taxes over a 20-year period. The Service clearly proved the long term failure to pay; however, the court found that it must determine if “this relief is necessary and proper ‘in light of the public interest involved.’” Similar to the court in the Padron case, the court in the Moore case found no controlling circuit authority and looked for authority from the other district courts in its circuit.
Even though it quoted language stating that the standard included the totality of the circumstances such as the reasonable likelihood that the taxpayer would violate federal tax laws again, the court in Moore found that “applying that standard, the injunction sought by the United States is overbroad and premature. It would force a shutdown of Dr. Moore’s dental practice and stop him from practicing dentistry entirely until the tax liabilities are paid. Such a harsh result is not only unprecedented but also premature given that no efforts or supplemental proceedings have been taken to satisfy this judgment.” At the same time it sought the injunction, the Service obtained a judgment against Mr. Moore for his failure to pay taxes over a substantial period.
While the Service has the ability to obtain an injunction, the Moore case shows that courts have split in a fairly significant manner on the appropriateness of this remedy or the proof that the Service must provide in order to obtain an injunction. The Moore case involves a very long period of non-payment and high amounts of non-payment. Much of the non-payment of employment taxes no doubt got credited to Mr. Moore when he filed his own individual tax return each year. I proposed in a law review article many years ago that responsible officers should not get withholding credit on their own returns when the business does not pay over the withheld taxes to the IRS. Mr. Moore seems like a poster child for that recommendation. Though the district court in Moore was concerned that he would not be able to repay the taxes if he can no longer practice dentistry, I do not think the injunction prohibits him from practicing dentistry as an employee of another dentist. It just seeks to keep him from running his own business and not paying his taxes. The facts in his case convince me that he should be an employee and not a business owner.