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The volunteer chair of the board of a nonprofit school for aeronautics may be a "responsible person" personally liable for the failure to withhold federal payroll taxes, according to the District Court for the Northern District of Illinois. (Schumacher v. U.S., No. 97 C 6806, 8/17/98.)

Board Chair Responsible?

By Don Kramer
From Nonprofit Issues

The volunteer chair of the board of a nonprofit school for aeronautics may be a "responsible person" personally liable for the failure to withhold federal payroll taxes, according to the District Court for the Northern District of Illinois. (Schumacher v. U.S., No. 97 C 6806, 8/17/98.)

The Aero Space Institute sought a merger partner in the late 1980s and met with Lawrence Schumacher, president of Northwestern Business College. Schumacher was interested in a possible affiliation and, in 1987, was appointed head of the Aero Space Board.

The Institute’s chief financial officer was responsible for the day-to-day operations and periodically sent Schumacher a list of the Institute’s payable bills.

Later, a new chief operating officer was appointed, and the list went to him and not to Schumacher. In 1992, the school went into financial collapse and failed to pay income and social security taxes for the first two quarters. The board later decided to close the school.

On audit, the IRS assessed a $42,872.63 penalty against Schumacher for failure to pay the taxes.

Schumacher argued he was not responsible. The Court said the key question is "whether he retained sufficient control over corporate finances that he was able to allocate corporate funds to pay corporate debts other than its withholding tax obligations. Whether Schumacher actually exercised his power is irrelevant; it is sufficient to show that he could exercise it if he so chose. Furthermore, Schumacher cannot escape liability by delegating his authority" to others.

Schumacher said, and it was not disputed, that he was never involved in the day-to-day management of the Institute. He was not directly involved in deciding what bills were paid after the arrival of the new chief operating officer. He was not authorized to sign checks. He never saw the payroll ledger prior to the school’s closing and never saw the withholding tax returns.

Not conclusive, said the Court. The government’s theory was that Schumacher either controlled the new COO or delegated his authority to him, which meant that he controlled the Institute’s finances.

The Court said Schumacher’s authority was a question of fact to be decided at a trial.

Schumacher also argued that his actions, even if he had the authority, were not "willful" as required by the statute to impose the personal liability.

Willful does not require bad faith or an intent to defraud, the Court said. "Mere knowledge that withholding taxes have not been paid might be sufficient," it said. "A responsible person acts willfully when he permits funds of the corporation to be paid to other creditors when he is aware that withholding taxes due to the government have not been paid."

The biggest risk of personal liability for an officer or director of a nonprofit organization probably lies in allowing the organization to fail to pay its withholding taxes when the finances begin to crumble. The natural tendency is to pay the loyal staff and to try to continue the program. But financing those operations with unpaid withholding taxes is a huge personal risk.

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Reprinted from the September 1998 issue of Don Kramer’s Nonprofit Issues®. For more information about the publication call 1- 888-NP-Issue or visit the Website at http://www.nonprofitissues.com.

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