Phillips v. U.S. I.R.S.

Decision Date10 January 1996
Docket NumberNo. 93-16619,93-16619
Parties-379, 64 USLW 2445, 96-1 USTC P 50,057, Unempl.Ins.Rep. (CCH) P 15083B, 96 Cal. Daily Op. Serv. 243, 96 Daily Journal D.A.R. 356 Mary E. PHILLIPS, Plaintiff, v. UNITED STATES INTERNAL REVENUE SERVICE, an Agency of the United States Government; United States of America, Defendants-Counter-Claimants-Appellees, and George A. Wray, Counter-Defendant-Appellant.
CourtU.S. Court of Appeals — Ninth Circuit

Michael A. Pollard (on the briefs), and William M. Sneed (argued), of counsel, Baker & McKenzie, Chicago, Illinois, for counter-defendant, appellant.

Frank P. Cihlar, United States Department of Justice, Washington, DC, for counter-claimants, defendants-appellees.

Appeal from the United States District Court for the District of Hawaii.

Before: REINHARDT, THOMPSON and KLEINFELD, Circuit Judges.

Opinion by Judge KLEINFELD; Dissent by Judge REINHARDT.

KLEINFELD, Circuit Judge:

This case involves the duty of a "responsible person" to pay his company's withholding taxes. More particularly, the issue is the definition of "willfully" failing to pay.

Facts

Mr. Wray founded South Pacific Island Airways, Inc., in American Samoa. He owned all the stock in the corporation, and ran it as president.

In 1984, Mr. Wray was paralyzed from the neck down in a swimming accident. While he was in the hospital, a company plane veered off course in Norway, into or near Soviet air space. The FAA revoked the company's certification because of that and other violations. As a condition of recertifying, the FAA required Mr. Wray and others previously in charge to resign their corporate offices.

The company still belonged entirely to Mr. Wray, however, and he caused the bank account to be moved into one for which he would have signing authority. Mary Phillips, the plaintiff, became the person running the company on a day to day basis. During the first two quarters of 1985, while Mr. Wray was confined to his apartment by his paralysis, the company did not pay its employee withholding taxes over to the IRS.

The jury heard conflicting stories of how the withholding taxes for the first six months of 1985 came to be delinquent. According to Mr. Wray, Ms. Phillips had let the withholding taxes go into arrears in 1982, and when he found out about it from an IRS notice, he paid them and told her never to let that happen again. In 1985, after his accident, he heard that Ms. Phillips had laid off most employees, because the airline was not flying, yet kept all of her own staff. For that and other reasons, he moved the bulk of the company money into an account for which he, instead of Ms. Phillips, would have signing authority. But Mr. Wray could not physically perform the duties of a person running the company, and he had been required to resign by the FAA. Ms. Phillips would request funds from Mr. Wray, and he would make them available to her "as long as she gave a reason for it." She would call Mr. Wray once or twice a week to request funds, and Mr. Wray would arrange for checks to be delivered to Ms. Phillips. Ms. Phillips never mentioned to Mr. Wray that the taxes were not being paid, and he would have paid them if he had known.

Ms. Phillips gave a conflicting account. She testified that after the FAA shut down operations, the airline was in desperate financial condition, and Mr. Wray said the top priority was to get it flying again. She testified that he picked which creditors should get paid. When she told him the company owed withholding taxes, he told her not to pay them. Even though he was confined by his injuries, Mr. Wray controlled the money, and she could not pay the taxes without his authorization.

Initially, the IRS sought the taxes from Ms. Phillips, as the "responsible person" under 26 U.S.C. Sec. 6672 for the first two quarters of 1985. She paid enough so that she could sue for a refund in district court. Mr. Wray was joined as a defendant on the IRS counterclaim. Ms. Phillips wound up escaping liability for the taxes, and Mr. Wray, in a subsequent trial, was stuck with a judgment for $368,812 plus interest. Mr. Wray appeals.

Analysis

"The standard of review on appeal for an alleged error in jury instructions depends on the nature of the claimed error." Oglesby v. Southern Pacific Transp. Co., 6 F.3d 603, 606 (9th Cir.1993). If it is the district court's formulation of an instruction which is claimed to be in error, we review the instructions as a whole for abuse of discretion by determining whether the instructions, considered as a whole, were inadequate or misleading. Gizoni v. Southwest Marine Inc., 56 F.3d 1138, 1142 n. 5 (9th Cir.1995); Jenkins v. Union Pacific Railroad Co., 22 F.3d 206, 210 (9th Cir.1994); Oglesby, 6 F.3d at 606. When the claim of error is that the district court misstated the elements that must be proved at trial, however, we review the instruction de novo. Gizoni, 56 F.3d at 1142; Jenkins, 22 F.3d at 210; Oglesby, 6 F.3d at 606. In either case, reversal is unnecessary if it is more probable than not that the error in the instructions is harmless. Jenkins, 22 F.3d at 210.

In the present case, Mr. Wray does not dispute that the "willfulness" element for a violation of 26 U.S.C. Sec. 6672 may be satisfied by a showing of "reckless disregard," or that the district court misstated the elements of a violation of Sec. 6672. Rather, he argues that the district court erred in formulating the definition of "reckless disregard." We therefore review the instructions as a whole for an abuse of discretion.

We also review admission of evidence for abuse of discretion. United States v. Herrera-Medina, 609 F.2d 376, 379 (9th Cir.1979).

A. Willfulness.

Mr. Wray concedes that, despite his physical indisposition, he was a "responsible person." He owned the company and controlled the bank account from which the money had to be drawn, and he directed which bills were to be paid. The issue is whether, as a responsible person, he "willfully" caused the money withheld for taxes not to be paid over to the IRS. His theory of the case was that he did not know the taxes were not being paid, so his failure to pay them was not "willful."

The controlling statute makes a responsible individual personally liable for a company's unpaid withholding taxes only if he "willfully" fails to pay them:

Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.

26 U.S.C. Sec. 6672 (emphasis added).

If a responsible person knows that withholding taxes are delinquent, and uses corporate funds to pay other expenses, even to meet the payroll out of personal funds he lends the corporation, our precedents require that the failure to pay withholding taxes be deemed "willful." Sorenson v. United States, 521 F.2d 325 (9th Cir.1975); Teel v. United States, 529 F.2d 903 (9th Cir.1976). This may seem oppressive to the employer and employees, Sorenson, 521 F.2d at 329, and amount to "unwittingly" willful, Teel, 529 F.2d at 905, which seems an oxymoron, but the proposition is established law.

Where a chief executive officer spent his time in the field making money for the business, left cosigned checks with his controller to pay the bills, and did not know his controller was failing to pay over the withholding taxes to the IRS, "[t]he question is one of fact" whether the nonpayment was willful, because the facts allowed for the possibility that the chief executive was "negligent, which is not willfulness." United States v. Leuschner, 336 F.2d 246, 248 (9th Cir.1964). But when he did it again in a second company, with the same controller, when he knew that the controller had once failed in the past to pay over the withholding taxes, and the chief executive did nothing to prevent a recurrence, that was willfulness as a matter of law. Id.

We have construed the term "willfulness" for purposes of failing to pay over withholding taxes as a "voluntary, conscious and intentional act to prefer other creditors over the United States." Klotz v. United States, 602 F.2d 920, 923 (9th Cir.1979); Davis v. United States, 961 F.2d 867, 871 (9th Cir.1992). No bad motive need be proved, and conduct motivated by reasonable cause, such as meeting the payroll, may be "willful." Davis, 961 F.2d at 871; Sorenson, 521 F.2d at 327.

"But the Government must prove more than mere negligence." Klotz, 602 F.2d at 924. Where a corporate officer sent the IRS a check, but the IRS did not negotiate it until a month later when the officer had been forced out of power and the corporation dishonored his check without his knowledge, his failure to pay the taxes was non-willful as a matter of law. Dudley v. United States, 428 F.2d 1196 (9th Cir.1970). Even if he was negligent, "negligence is not willfulness." Id. at 1200.

We have said that "reckless disregard" of whether the taxes are being paid over, as distinguished from actual knowledge of whether they are being paid over, may suffice to establish willfulness. Sorenson, 521 F.2d at 329; Teel, 529 F.2d at 905. Other circuits so hold. See, e.g., Kalb v. United States, 505 F.2d 506, 511 (2d Cir.1974); Wood v. United States, 808 F.2d 411, 415 (5th Cir.1987); Sawyer v. United States, 831 F.2d 755, 758 (7th Cir.1987); Malloy v. United States, 17 F.3d 329, 332 (11th Cir.1994).

Mr. Wray's argument on appeal is that the district court instruction allowed the jury to find willfulness based on mere negligence, by defining reckless disregard so that it meant no more than negligence. He does not dispute that reckless disregard of...

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