Refund Suits, Divisible Taxes and Flora: When is a representative payment representative enough? Part 2

This is the second post by guest blogger Rachael Rubenstein.  Today’s post is co-authored with clinic student, Andre Anziani, regarding the clinic’s significant victory in the Kaplan case.  In this segment, they specifically discusses the amount of the refund necessary to satisfy the Flora test in a Trust Fund Recovery Penalty (TFRP) case.  Refer here to her prior post on Kaplan.

Before we turn back to the specifics of the jurisdictional challenge in the case, a bit of background on section 6672 and the development of the Flora divisible tax exception are helpful.  Congress designed section 6672 to impose civil penalties against persons whom the Service determines have failed as employers to perform their employment tax (FICA and Federal income tax) withholding and/or remitting obligations.  Section 6672 allows the Service to pierce through the entity veil and asses the tax penalty directly against individuals responsible for the entity’s failure to pay.  The amount is equal to one hundred percent of all employee portions of unpaid FICA and Federal income taxes not provided to the government as required by I.R.C. §§ 3102, 3402(a).  In order to be found personally liable for a company’s failure to pay employment taxes under section 6672, a party must be found 1) responsible, and 2) willful.  Questions of responsibility and willfulness are fact intensive investigations with many factors developed through decades of case law to consider, such as: day-to-day management authority, check signing authority, and responsibility for hiring employees, and control over disbursement of payroll.  Many taxpayers and their representatives believe that section 6672 penalties are over assessed at the agency level because examiners don’t have adequate time and training to really conduct an intensive fact and law analysis of a potentially liable taxpayer.  Additionally, courts vary a great deal in their interpretations of how the factors apply to any given set of facts in the cases before them.  Arguably, recognition of the complexity involved in assessing and challenging section 6672 penalties played a role in shaping the exception to the Flora full payment rule, along with the uniform characterization of section 6672 assessments as divisible taxes.

In the past several decades, the government seldom contested modest representative payments, such as Kaplan’s, because of the development of the divisible tax exception in tax refund suits.  The first major cases that carved out this exception to Flora were Steele v. United States and Boynton v. United States.  Steele, a case from the Eighth Circuit, was decided in 1960, the same year as Flora; it held that “the full-payment rule is not applicable to an assessment of divisible taxes.”  Steele, 280 F.2d at 90.  The court determined that the plaintiff was entitled to make a payment applicable to the withholding of any individual employee to make a claim for a refund.  Id. at 90.  In 1977, the Ninth Circuit ruled in Boynton that a taxpayer’s refund suit is proper when the plaintiff pays the assessment fully or pays a properly divisible portion of the assessment.  Boynton, 566 F.2d at 56-57.  The Boynton court reasoned that a section 6672 assessment represents a cumulation of separate employee assessments.  Thus, a plaintiff may pay a portion of the withholding taxes attributed to a single employee to form the basis of a refund suit.  Id. at 52.  Since these cases, the majority of appellate circuits have followed suit.  Indeed, a shorthand practice of paying a representative figure such as $100–$200 towards the penalty assessment along with an administrative claim for refund developed as a means to get taxpayers into court expeditiously in order to challenge their liability under section 6672.


Kaplan was assessed the penalties due to his involvement in a San Antonio, Texas restaurant.  The restaurant opened in 2007, just as the great recession hit.  Needless to say, the IRS never received any employment tax payments.  Kaplan was an investor in the restaurant and owned a minority ownership interest in the entity that operated the restaurant.  As such, he did not have access to employee records, except for one wage report from the state that detailed each restaurant employee’s cumulative wages for the last quarter in 2008; a quarter which was not part of his assessment.  In order to contest his ultimate liability for the penalties, he decided to utilize the common practice of paying a modest representative amount along with an administrative claim for refund.  Based on the records he had, and his knowledge of the generally low wages paid in the industry, $100 payments seemed reasonable and appropriate to cover the withholding taxes for, at least, one employee for each of the three quarters.  Nonetheless, Kaplan and counsel diligently tried to obtain additional employee records, even after filing the suit for refund. These attempts yielded very little new evidence, except payroll records for one week in the third quarter of 2008.

Over a year after Kaplan’s complaint was brought, and less than two months before trial was set, the government challenged the sufficiency of the payments in a motion to dismiss for lack of subject matter jurisdiction.  This motion was initially successful.  Judge Wheeler’s first opinion in the case, on October 9, 2013, dismissed Kaplan’s case for lack of jurisdiction; ruling that he could not carry his burden of showing , by a preponderance of the evidence, that his payments equaled a sufficient amount of divisible tax attributable to one employee for each of the assessed quarters.  Kaplan filed a motion for reconsideration, which was granted.  The court vacated its first opinion and held that denial of jurisdiction in the case was manifestly unjust.

The reason for the change lies in the “competing evidentiary burdens imposed by the jurisdictional and liability standards in this type of divisible tax refund suit.”  Kaplan, like most plaintiffs in 6672 cases, contests the Service’s determination that he was a “responsible person” who had a legal duty to withhold/remit employee payroll taxes for the company.  However, in order to establish subject matter jurisdiction for the refund suit, Kaplan must prove by a preponderance of the evidence that he has paid the assessed tax for at least one employee.  Kaplan’s central argument in his motion for reconsideration was that the court’s dismissal of his case effectively concluded that he was a “responsible person” with a duty to maintain employee tax records before he had the opportunity to present the merits of his case. In granting the motion, the court acknowledged the “evidentiary Catch-22” Kaplan was caught in, assuming he was truly not responsible under section 6672.

In his motion for reconsideration, Kaplan offered further support for the sufficiency of his $100 payments by citing IRM section, which states that “[i]f the amount required cannot be accurately determined, the Service may accept a representative amount.”  The last paragraph of the court’s revised opinion concluded, “[i]n the end, the merits of this case will turn on whether Mr. Kaplan is liable for the full [amount of the assessed] penalt[ies], and the divisible amount at issue is merely representative of that full amount . . . Under the circumstances of this case, the Court is not inclined to prevent Mr. Kaplan from challenging that full assessment in this forum simply because the representative amount he paid might not be representative enough.”  We gratefully acknowledge Larry Jones and Jack Townsend for pointing out this IRM citation, which we read on Townsend’s Federal Tax Procedure blog while researching the motion.

Rather than eagerly announce that there is now a new jurisdictional rule in section 6672 cases, we think it’s important to note that there were some unique circumstances in this case that, perhaps, prevent broad application of the decision.  First, we were able to recount for the court in detail (along with evidentiary exhibits), the diligent (but futile) search made for employee records.  Second, the government was unable to produce any records to show what minimum payments would be sufficient.  Third, the government had already tried, unsuccessfully, to deprive Kaplan of his choice of forum by filing its own suit in the Western District of Texas to litigate the issue of liability under section 6672.

That said, we do believe this case is important because, as Professor Townsend observed, “it is a further holding in a line of cases [involving the question of section 6672] responsibly, [which] mitigate[s] the full bore and inequitable application of the Flora rule.”  After all, the Tax Court does not have jurisdiction over these types of assessments, so the deficiency procedures that allow taxpayers to challenge first and pay later are unavailable.  Thus, the real purpose of the refund suit in section 6672 cases isn’t for taxpayers to get back their divisible tax payment(s), but rather to permit them a “day in court” to challenge their underlying liability for the Trust Fund Recover Penalty assessments.  When viewed in this context, Judge Wheeler’s decision is a huge victory, not only for Mr. Kaplan, but also other taxpayers who may lack employee records but still want the opportunity to contest the penalty assessments without the harshness of the Flora rule standing in their way.

We would like to further acknowledge and thank the tax pros who offered their support, and technical expertise to the tax clinic program at different stages of the case: Farley Katz and Elizabeth Copeland from Strasburger & Price, LLP; as well as Charles Ruchelman, Peter Lowry, and Travis Greaves from Caplin & Drysdale.