482 F.3d 792 (5th Cir. 2007), 06-20292, Staff IT, Inc. v. United States

Docket Nº:06-20292.
Citation:482 F.3d 792
Party Name:STAFF IT, INC., a Texas Corporation, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
Case Date:March 22, 2007
Court:United States Courts of Appeals, Court of Appeals for the Fifth Circuit

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482 F.3d 792 (5th Cir. 2007)

STAFF IT, INC., a Texas Corporation, Plaintiff-Appellant,


UNITED STATES of America, Defendant-Appellee.

No. 06-20292.

United States Court of Appeals, Fifth Circuit

March 22, 2007

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David Overholt Stevens (argued), Houston, TX, for Plaintiff-Appellant.

Carol A. Barthel (argued), Thomas J. Clark, U.S. Dept. of Justice, Tax Div. Appellate Section, Washington, DC, Christopher R. Egan, U.S. Dept. of Justice, Tax Div., Dallas, TX, for Defendant-Appellee.

Appeal from the United States District Court for the Southern District of Texas.

Before GARWOOD, WIENER, and CLEMENT, Circuit Judges.

WIENER, Circuit Judge:

Plaintiff-Appellant Staff IT, Inc. ("S.I.") failed to file, pay, and deposit payroll taxes during the course of three tax quarters. The Internal Revenue Service ("IRS") initiated collection proceedings against S.I., seeking the unpaid taxes, interest on them, and penalties for S.I.'s failure timely to file, pay, and deposit such taxes. After the IRS Office of Appeals administratively sustained a proposed levy, S.I. filed a complaint

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in the district court, contending that, because of financial hardship, it should be excused from paying the penalties. The district court ruled against S.I., which then appealed to us.

On appeal, the government relies on Brewery, Inc. v. United States 1 in arguing that financial hardship can never be a justification for the abatement of employment tax penalties. In diametric opposition, S.I. relies on caselaw from the Second, 2 Third, 3 Seventh, 4 and Ninth Circuits 5 in arguing that financial hardship may justify the abatement of employment tax penalties, insisting that it does so under the facts and circumstances present here.

Like the district court, we need not decide today whether financial hardship may ever justify the abatement of employment tax penalties. Instead, we hold that S.I. is not entitled to an abatement of penalties even when we assume arguendo that, under some circumstances, penalties for failure to file, pay, and deposit payroll taxes could be abated for financial hardship.


S.I. is an accrual-basis taxpayer operating out of Houston, Texas. It was incorporated in 1996 as a personnel staffing company specializing in providing computer programmers and other technical personnel ("contractors") to outside businesses ("clients"). Typically, clients would engage S.I. to fill vacancies in their computer programmer or other technical positions.

Contractors hired by S.I. would be placed on S.I.'s payroll, but would work under the designated client's direction. Each pay period, S.I. would pay the contractors their net compensation after withholding such items as income and social security taxes. S.I. would invoice the client for the contractors' services, including a surcharge for S.I. Clients would usually pay S.I. within thirty to ninety days after being invoiced.

Based on its invoicing practice, S.I. had to carry its costs between the time it paid its contractors and the time it received payment from its clients. This practice required substantial working capital to cover the resulting time gap. Some of this required capital came from S.I.'s officer-stockholders who invested in or made loans to S.I., but S.I. still had to borrow a significant portion of its working capital from financial institutions.

As a relatively small business with no "hard" assets, such as land, buildings, equipment, or manufacturing facilities, S.I. was not able to borrow capital from traditional banks. Other than a few computers, desks, and chairs, S.I.'s only assets were its accounts receivable, which mainline banks ordinarily deem to be insufficient collateral. Thus, S.I.'s only source of working capital was financing companies ("factors" or "factoring companies").

In the factoring process, a business sells its accounts receivables to a finance company at a discount. Then, as the business collects its receivables, it repays the factor. (In some cases, clients pay the factor directly.)

In 2001, S.I. obtained financing through Prinvest Capital Corp. ("Prinvest"), a factoring company. Under the factoring agreement, Prinvest would advance S.I.

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approximately seventy to eighty percent of the revenue expected from a S.I. client, and S.I. would instruct the client to pay Prinvest directly. Then, when Prinvest received payment from the client, Prinvest would deduct its charges and forward the remainder to S.I. By mid-2001, S.I.'s annual billings had grown to approximately $16,000,000.00, and Prinvest was financing approximately one-third of S.I.'s receivables.

S.I. employed more than two hundred contractors, had accrued monthly revenues of almost $1,600,000.00, and had a monthly cash flow of over $2,000,000.00. S.I.'s payroll taxes were almost $3,000,000.00 in 2000 and almost $2,000,000.00 from January to September 2001. Until the last tax quarter of 2001, S.I. timely filed, paid, and deposited its payroll taxes.

Beginning in May 2001, S.I. began to experience a series of financial set backs. During the months of May, June, and July 2001, S.I.'s largest client, Compaq Computer, laid off a significant portion of its workforce, including 55 of its 106 S.I. contractors. As a result, S.I. lost $400,000.00 in revenue. During the same period, Enron and Dynegy, smaller S.I. clients, laid off 12 S.I. contractors.

In June 2001, as a response to the Compaq lay-offs, Prinvest refused to finance any more of S.I.'s receivables, eventually declaring bankruptcy in August of that year. This left S.I. with no financing source. S.I. began negotiations with another potential lender to replace Prinvest and obtained an informal financing agreement in September. This eventually fell through, however, during the period of financial uncertainty that followed the September 11, 2001 terrorist attacks.

In October 2001, Prinvest demanded a substantial loan repayment from S.I., threatening to contact S.I.'s clients directly and call in all S.I.'s receivables if the repayment were not made. Rick McMinn, a S.I. officer and 40% stockholder, together with S.I.'s other two officer-stockholders, personally guaranteed Prinvest's loan to S.I. McMinn used his home as collateral in borrowing $300,000.00, which he then loaned to S.I. on the same terms that the bank had loaned that money to him. S.I. used those funds to pay the $300,000.00 to Prinvest.

S.I. cut some minor expenses during this period. Some of these expenses were not eliminated, however, but were merely deferred until the following month.

S.I. continued to place contractors at Enron and Compaq in October 2001, despite announcements that these two clients would indefinitely suspend invoice payments. S.I. cut other "G&A" costs--a catch-all category of expenses--including some advertising and recruiting expenses, but did not issue a broad directive to cut expenses. S.I. paid $100,000.00 to creditors other than Prinvest in October while increasing its marketing efforts by shifting two staff employees from the recruiting of contractors to the selling of S.I.'s services (i.e., marketing). The marketing efforts were part of S.I.'s plan to overcome its financial difficulties by "growing" the business and catching-up.

Enron continued to weaken in November and December of 2001, eventually filing for bankruptcy protection. S.I. lost approximately $450,000.00 in receivables as a result, but did not file a claim in the bankruptcy proceeding because of the attendant expenses and fees and the likelihood of an unfavorable result.

S.I. failed to make payroll tax deposits in November and December 2001. During these months, S.I. delayed payments to some third-party creditors and on some debts, but did not reduce (1) the number of contractors on its payroll, (2) the number of its employees, or (3) salaries (not even the salaries of its three officer-stockholders at $240,000 per annum each). Neither

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did S.I. issue a broad directive to reduce expenses. At that time, S.I. was anticipating a growth in business from its increased marketing efforts, which S.I. hoped would enable it to pay its past-due fourth quarter 2001 payroll taxes, as well as to make timely deposits of its 2002 payroll taxes.

S.I. continued to spend on marketing, advertising, and operating expenses. It also continued to provide monthly vehicle allowances for those of its employees who had to drive to clients' places of business, and to take clients to Houston Astros games, including paying for season parking. During the time in question, S.I. spent $3,500.00 on a Christmas party, expended additional funds for promotional items, such as drink koozies and rulers, and paid $800.00 for Christmas hams for its contractors. S.I. also continued to entertain clients by treating them to meals. S.I. justified these expenses as part of its advertising and client-relations efforts.

By early 2002, S.I.'s anticipated business increase had failed to materialize and its existing business declined. S.I. had still not obtained a new factor to replace Prinvest...

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