KOBUS v. USA
Filing
47
PUBLISHED OPINION. Joint Status Report due by 3/29/2012. Signed by Judge Edward J. Damich. (tb3) Copy to parties.
In the United States Court of Federal Claims
No. 09-837T
(Filed: February 28, 2012)
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LOUIS KOBUS, JR.,
Plaintiff,
v.
THE UNITED STATES,
Defendant.
26 U.S.C. § 6672; withholding taxes; willful;
trust fund penalty; refund and collection suit;
presumption of correctness;
taxpayer’s burden of proof; estimates;
substitute return; 26 U.S.C. § 6020;
redemption; 26 U.S.C. § 7425
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John F. Rodgers, Redmon Peyton and Braswell LLP, Alexandria, VA, for Plaintiff.
Jason Bergmann, Trial Attorney, Tax Division, with whom was Shelley D. de Alth, Trial
Attorney, Tax Division, United States Department of Justice, Washington, DC, for Defendant.
________________________
OPINION & ORDER
________________________
DAMICH, Judge:
This is a tax refund case concerning penalties that the Internal Revenue Service (“IRS”)
assessed on and collected from Plaintiff Louis Kobus, Jr. The main issue in this case is whether
it was proper for the IRS to assess Kobus with tax penalties for his role in allowing his
corporation, Village Turf, Inc., to fail to pay over to the government the taxes it had withheld
from its employees’ paychecks (“withholding taxes”). Kobus claims he is entitled to a refund of
all amounts the IRS has collected from him. The Government counterclaims to collect the
unpaid balance of the penalties, plus interest and fees. The amounts at issue total approximately
$315,000.
The IRS assessed the penalties under 26 U.S.C. § 6672, which permits the IRS to assess a
personal penalty, equal to the amount of the taxes not paid by the employer, on any person who
is responsible for ensuring that the employer collects and remits withholding taxes and who
“willfully” fails to have the employer collect, account for, or pay such taxes. The parties do not
dispute that Plaintiff, who was Village Turf’s founder, president, and sole and controlling
shareholder, was responsible for collecting and remitting the taxes. The main factual dispute is
whether Plaintiff willfully failed to pay over the withholding taxes. Under § 6672, a taxpayer
acts willfully if either he knowingly fails to pay withholding taxes or he acts with a reckless
disregard of a risk that withholding taxes will not be paid.
To resolve the disputed factual issues relating to willfulness, the Court held a two-day
trial on October 26 and 27, 2011, with closing arguments held on December 1, 2011. 1 The
issues have been fully heard, and this case is now ready for decision.
After careful consideration, the Court finds that Kobus is liable for the penalties. The
Court finds that, during most of the periods at issue, Kobus knew that Village Turf was not
remitting its withholding taxes and he chose not to pay over the funds to the IRS. For the
remainder of the periods, the Court finds that, after Kobus learned that Village Turf had not paid
over withholding taxes in past tax periods, Kobus chose not to pay the past deficiencies, despite
having funds to do so. Therefore, Kobus willfully failed to pay over the withholding taxes and
he is liable for the tax penalties for all periods at issue.
I.
Background
A.
Withholding Taxes and The Penalties Assessed on Kobus
The Internal Revenue Code imposes on every employer the obligation to collect from its
employees both federal income taxes and Federal Insurance Contributions Act (“FICA”) taxes.
26 U.S.C. §§ 3101, 3102, 3111, 3402 (2006). Employers collect the taxes by withholding funds
from employee wages. §§ 3101, 3111. Employers do not immediately remit the withheld taxes
to the government; instead, they hold the funds “in trust” until they remit the funds by making a
federal tax deposit at an authorized financial institution. Id. at § 7501. The taxes withheld from
wages commonly are referred to as withholding taxes or trust-fund taxes. When the employer
makes a withholding-tax deposit, the employer also must remit a matching FICA tax payment for
each employee. 2
Employers typically remit withholding-tax deposits on a semiweekly or monthly basis. 3
The IRS requires each employer to file a withholding-tax return, which the IRS uses to track
deposits and to calculate the employer’s withholding tax liability. Most employers are required
to file a withholding-tax return each quarter (Form 941). The IRS permits seasonal employers to
1
Citations to the trial transcript will be “Tr. at __” and citations to the closing argument transcript
will be “Closing Arg. Tr. at __”.
2
FICA taxes are comprised of a 12.4% tax for Social Security and a 2.9% tax for Medicare, with
half being paid out of employee wages and half being paid by the employer. §§ 3101, 3111. Only the
employee’s half of the FICA tax is considered a withholding tax. The effect of this system is that every
employee’s salary is actually 7.65% higher than listed on a paycheck because the employer is making a
FICA tax payment on behalf of the employee that the employee does not see.
3
At the times at issue in this case, the funds were paid over to the IRS by making a deposit at a
bank with a tax coupon. Now payments can be made electronically. Tr. at 367.
2
account for the taxes by filing one return annually (Form 943). For some of the tax periods at
issue in this case Village Turf filed quarterly returns and for some it filed annual returns.
Withheld taxes are credited to the employee regardless of whether the employer pays
them to the Government. Because the employer is not required to pay over the funds upon their
collection, the withheld amounts can “be a tempting source of ready cash to a failing corporation
. . . .” Slodov v. Unites States, 436 U.S. 238, 243 (1978). To prevent misuse of the funds, the
IRS not only will hold the employer liable for any unpaid withholding taxes, but it also can
assess a personal penalty, equal to the amount of the unpaid taxes, on any person who is
responsible for the employer’s failure to pay the taxes. Id. at 244-45; Godfrey v. United States,
748 F.2d 1568, 1574-75 (Fed. Cir. 1984); § 6672.
In this case, it is undisputed that, between 1996 and 2003, Village Turf did not pay over
to the IRS most of the taxes it had withheld from its employees’ paychecks. After Village Turf
did not take any action to pay its deficiencies, the IRS assessed a personal penalty on Kobus.
There is no question that Kobus, who was Village Turf’s founder, president, and controlling
shareholder, was the person responsible for ensuring the company was collecting and remitting
its withholding taxes. 4
The IRS assessed the penalties for 12 distinct tax periods: 1996, 1997, 1998, 1999, 2000,
2001, the second quarter (“Q_”) of 2002, Q3 2002, Q1 2003, Q2 2003, Q3 2003, and Q4 2003.
Through levies and garnishments, the IRS has collected money in satisfaction of the penalties for
1996 to 2000 and for some of 2001. Plaintiff requests a refund of all payments that the IRS has
collected from him. Kobus has a remaining unpaid penalty balance for part of 2001 and for all
of Q2 2002, Q3 2002, Q1 2003, Q2 2003, Q3 2003, and Q4 2003. The Government
counterclaims to collect the outstanding balance of the unpaid penalties. Kobus filed an
administrative appeal with the IRS on July 7, 2004, but the IRS Appeals Division denied the
appeal on November 4, 2005. Joint Exhibit (“Ex.”) 71; Ex. 66 at 14; see Tr. at 365. Kobus then
filed this case on December 7, 2009.
The primary factual issue is whether Kobus willfully failed to pay over the withholding
taxes. However, this case also presents several ancillary issues that the Court must resolve. As a
preliminary matter, the Court must determine the proper allocation of the burden of proof
because the parties dispute who bears the burden of proving that Kobus acted willfully.
Complicating this issue is the Government’s contention that Kobus should be liable for the
spoliation of the evidence because many of Village Turf’s business records were lost or
destroyed after the IRS began investigating Village Turf. Next, Kobus argues that, if the Court
determines he acted willfully, his 2003 liability should be reduced because the IRS’s penalty
assessments were based on incorrect estimates of Village Turf’s annual wages. Finally, Kobus
argues that the Government improperly preferred itself to Kobus’s other creditors when it
purchased and resold Kobus’s house after a senior creditor foreclosed on it.
4
The IRS also assessed the § 6672 penalties on Susan Clay, and she and Kobus are jointly liable
for the penalties. From 2000 to 2002, Clay was listed as the corporate secretary on Village Turf’s state
registration. Her role in this matter is discussed in detail, infra.
3
B.
Factual Background
1.
Plaintiff’s Operation of Village Turf
Kobus is an agricultural engineer, who served in the U.S. Marine Corps. for 23 years. Jt.
Stip. Facts (“Stip.”) ¶¶5, 7. During his service in the Marine Corps, Kobus held several
positions, including “Director of Facilities Management,” where he was responsible for a $17
million budget, and “Head of Budget and Programming,” where he prepared 5-year budgets. Tr.
97-99; see Stip. ¶6. In both positions, he was responsible for managing a large number of
personnel. Stip. ¶6. After he retired, he formed Village Turf, Inc., in 1993, which initially was a
landscaping and lawn maintenance business.
Village Turf was a Virginia corporation, and it operated out of various locations in
Fairfax County, Virginia. Stip. ¶¶8, 10. Kobus employed landscaping crews to do most of the
physical labor, and he oversaw the crews and handled quality control. Tr. at 24-28. Though he
performed some field work, Kobus spent most of his time promoting Village Turf and trying to
find new business and clients. Tr. at 24-28. Kobus also employed an office staff which handled
most of the day-to-day tasks of running the business. Throughout much of Village Turf’s
existence, Kobus was its only corporate officer. From May 2000 to March 2002, however,
Susan Clay officially was listed as Village Turf’s corporate secretary. Exs. 60, 62.
Sometime around 2000, Kobus was offered the opportunity to purchase a retail store and
a dealership agreement with Southern States Cooperative, Inc., a company that distributes
agricultural products. In 2001, Kobus purchased the store, and Village Turf entered into a
dealership agreement with Southern States. Before entering into the agreement, Village Turf
provided Southern States with several financial documents, including a balance sheet, income
statement, and profit-and-loss statement for 2000. Stip. ¶¶80-81. According to his testimony,
Kobus invested $450,000 in the store, including granting Southern States a $150,000 deed of
trust on his home as collateral for inventory purchases. Tr. at 76. He also signed several
Uniform Commercial Code (“UCC”) security agreements giving Southern States rights to his
inventory, proceeds from inventory, and other assets. Stip. ¶¶86-88. 5
As Kobus was busy working on the landscaping business, he decided that he would be
unable to dedicate his time to starting up and running the retail store, which was located 40 miles
away in Fredericksburg, Virginia. Tr. at 36-37. Consequently, Kobus hired Daniel Lagasse to
set up and manage the retail store. 6 Stip. ¶89. Lagasse set up the store’s financial systems, hired
its employees, and got the store ready for business. In June 2001, the retail store opened. Stip.
¶92.
5
Kobus also entered into similar agreements with Wetsel, Inc., another company that sold
agricultural products. Stip. ¶88.
6
Lagasse’s official title was “regional manager.” At the time, Kobus planned on opening a
number of stores, and he hired Lagasse to help him open and manage all of them. Tr. at 415-17; see Tr. at
193.
4
In 2001, Fairfax County charged Village Turf with a zoning violation over the company’s
use of the property where its landscaping office was located. The County asserted that Village
Turf’s construction of a storage shed and the overall character of its use of the property were not
consistent with the property’s zoning classification. Stip. ¶¶179, 302. The County imposed over
$100,000 of fines on Village Turf, Kobus, and Clay, the owner of the property. Stip. ¶180; Ex.
144. It also issued a final decree ordering Village Turf and Kobus to cease using the property as
a contractor’s office and shop with outdoor storage of construction equipment. Stip. ¶181; Ex.
142.
In 2003, Kobus attempted to set up a new corporate entity to operate the retail store. Tr.
at 69-70. In November 2003, Kobus formed VTSS, Inc., Ex. 64, and he acquired a new
employer identification number for the store from the IRS, Stip. ¶¶107-12. The record shows
that Kobus did not fully transfer control of the retail operations to VTSS during 2003, which is
the last period at issue in this case. 7
By 2004, Village Turf eliminated the landscaping side of its business because the
County’s zoning rulings had prevented Kobus from operating it. Then, in the first quarter of
2004, Lagasse resigned and left the retail store. Stip. ¶149.
Kobus continued to operate the retail store for another year, although it was difficult to
keep the business afloat. See Tr. at 62, 82 (store closed around February 2005). In 2005,
Southern States cut off Village Turf’s credit line. See Ex. 165 at 2; Tr. at 62. In 2005, Village
Turf was unable to pay rent on the retail store and the landlord evicted Village Turf from the
store location. In 2006, Virginia terminated Village Turf’s corporate existence. Stip. ¶8. After
Village Turf was evicted and the store closed, Southern States was unable to collect the
outstanding balance on Village Turf’s inventory account. In 2008, Southern States foreclosed on
its lien on Kobus’s home.
2.
The Role of Village Turf’s Office Staff in Tax Matters
As Village Turf’s owner, Kobus handled mostly higher level duties, such as quality
control and finding new business, and he delegated to his office personnel most of the day-to-day
tasks of running the business. The delegated tasks included the preparation of Village Turf’s
payroll and the collection and remitting of withholding taxes. Over the course of the tax periods
at issue, 3 different office employees had the duty of preparing Village Turf’s payroll. Each of
the 3 employees had different responsibilities at Village Turf, and each employee’s payroll
preparation duties varied based on their other responsibilities. In 1996, the first tax period at
issue, Evelyn Woods was the employee who was responsible for preparing payroll and for
remitting withholding taxes. Stip. ¶¶24-26. While Woods was working for Village Turf, the
company remitted most of the withheld taxes to the United States and it properly filed its
withholding-tax returns.
7
In 2003, Kobus’s efforts at separating the businesses were incomplete because he filed a joint
federal-income-tax return (Form 1120S) for the two businesses for that year. Stip. ¶112; Ex. 53 at 1, 9;
Tr. at 408-09. Additionally, it does not appear from the record that Kobus transferred Village Turf’s
agreements with Southern States to VTSS.
5
Around March of 1997, Woods retired, and around that time, Kobus began working with
Susan Clay. Stip. ¶¶31-32. Although Clay was not a Village Turf employee, she was
responsible for entering accounting data into the payroll system and for preparing the payroll. 8
Stip. ¶¶31, 170-71. Clay was not, however, explicitly assigned the duty to remit withholding
taxes. Stip. ¶¶170-71. Over the next few years, Clay became more involved with Village Turf,
and in 1999, she was given check signing authority on Village Turf’s bank accounts. See Stip.
¶19. In 1999, Village Turf relocated to a property owned by Clay, which she permitted Village
Turf to use rent-free. In May 2000, she was registered with the State Corporation Commission
as Village Turf’s corporate secretary. Ex. 60. Though Clay appears to have been fairly involved
with the business, she was never an official employee of Village Turf and never received a
regular paycheck. Tr. at 208, 213-14. Clay continued preparing the payroll for the landscaping
operation through 2003. Tr. at 420-23; see Tr. at 39, 192-93.
As noted earlier, in 2001, Lagasse began working for Village Turf, and Lagasse managed
many aspects of the retail store. It is undisputed that Kobus gave Lagasse authority to manage
the store, handle its payroll, 9 and pay at least some of the store’s bills, but the parties dispute the
extent of his bill-paying authority. The parties agree, however, that Kobus left much of the dayto-day management of the store to Lagasse, and that Kobus and Lagasse would meet every 1 to 2
weeks to go over the store’s finances and unpaid obligations. Stip. ¶¶100-01.
3.
Village Turf’s Tax Problems
The parties dispute when Kobus first knew that Village Turf was not paying its
withholding taxes. They agree, however, that by early 2002, “escalating federal and state taxcollection activities” lead Kobus to request Lagasse’s assistance. Stip. ¶124. 10 Kobus asked
Lagasse to investigate and solve the problem. After investigating, Lagasse discovered that, since
sometime in 1996 (i.e., just before Woods retired), Village Turf had not been paying over its
federal withholding taxes and it had not been filing the associated tax returns either. Tr. at 44446. As a result, the withheld taxes had not been turned over to the Government but instead were
used in the ordinary course of business. Lagasse prepared delinquent withholding-tax returns for
1996 to 2001, and on April 14, 2002, Village Turf filed the returns, Stip. ¶131, but the company
8
Clay testified that her payroll preparation duties involved entering hours and generating
paychecks. Clay explained that she would take the hours from the timesheets for each employee and post
them to the payroll system, which would apply the payroll rates and print the checks. Tr. at 189-90. She
testified that the system probably printed out checks for tax deposits as well, but that she did not
specifically recall. Id.
9
Lagasse explained the scope of his payroll preparation duties. Lagasse testified that after he set
up each employee’s profile in the payroll system, the system automatically calculated wages and taxes,
and it could generate reports. Tr. at 426-28. Each pay period he would enter the hours worked and the
system would generate the checks. Id.
10
The parties agree that, in early 2002, Kobus gave Lagasse a box that contained correspondence
from the IRS, some of which was not opened, and that Kobus told Lagasse that Clay was responsible for
the tax problems. Stip. ¶¶125-26; Tr. at 444-45.
6
failed to make any payments on its outstanding tax balances and to take any further corrective
actions. In 2002 and 2003, Village Turf continued to fail to remit the withholding taxes it was
collecting and it also failed to make any payments on its past-due taxes. Although Village Turf
did file withholding-tax returns for Q2 and Q3 of 2002, the company did not file any
withholding-tax returns for 2003. Stip. ¶¶138, 141, 290. 11
In July 2003, the IRS assigned Village Turf’s account to field officer Bonnie Shrewsbury,
who began investigating Village Turf and its tax problems. 12 Ex. 66; see Tr. at 346-47. Between
July and September 2003, Shrewsbury made several attempts to contact Village Turf, both by
letter and by telephone, but Kobus did not respond. Tr. at 350-53; Ex. 66 at 18. In October
2003, Kobus retained tax attorney Albert Schibani, who contacted Shrewsbury on Village Turf’s
behalf. Ex. 66 at 8.
When Schibani first contacted Shrewsbury on October 29, 2003, Shrewsbury told him to
have Kobus provide her with 3 months of business records and a Form 433(b), which is the first
form a taxpayer must file to start negotiating a resolution to a tax dispute. Tr. at 353-54; Ex. 66
at 8. These records were not provided. Ex. 66 at 12. On January 5, 2004, Shrewsbury again
asked for the Form 433(b), and warned Schibani that the IRS would pursue further enforcement
action if the form was not received. Ex. 66 at 10. On January 20, 2004, Schibani told
Shrewsbury that Village Turf was working on putting together the information and he should
have it in about a week, but he never submitted the information. Ex. 66 at 11-12. Shrewsbury
requested to visit the store to meet with Kobus, to see how business was going and to see the
records, but her request was not granted. Tr. at 356; Ex. 66 at 11.
By this time, Village Turf was experiencing major financial difficulties. The zoning
dispute referred to previously resulted in several substantial fines and caused Village Turf to
eliminate its landscaping operations. Stip. ¶180; see Ex. 144. Village Turf also was
experiencing major financial problems, and Lagasse resigned in the first quarter of 2004.
Meanwhile, the IRS had been continuing its investigation of Village Turf. Between
March and May 2004, the IRS sent Kobus several letters. Tr. at 357-58; Ex. 66 at 14-15. On
March 9, 2004, Shrewsbury visited the retail store, and her notes document that the store was
busy and in full operation. Based on her observations, Shrewsbury concluded that Village Turf
had funds to pay the deficient taxes but was choosing not to pay them, and she recommended
assessing a penalty on Kobus. On March 10, 2004, the IRS mailed Kobus a notice proposing to
assess a penalty on him personally. Tr. at 357. On May 12, 2004, Shrewsbury had the IRS mail
Kobus an appointment letter proposing to visit him at his home on May 25, 2004. Tr. at 358.
11
Prior to opening the retail store, Village Turf filed annual withholding-tax returns because it
was a seasonal employer. After opening the retail store, Village Turf began filing quarterly withholdingtax returns, as done by ordinary, non-seasonal employers. Village Turf did not, however, file separate
withholding-tax returns for the landscaping business and the retail store.
12
When asked to explain why the IRS waited until July 2003 to begin investigating Village Turf
when no withholding-tax returns were filed for many years, Shrewsbury testified that she could “only
assume that getting the [delinquent] returns filed [in April 2002] made the balances larger and made it
more reasons [sic] to issue the case to the field.” Tr. at 379.
7
On May 13, 2004, the IRS mailed Kobus a letter notifying him that he was being assessed with a
penalty under § 6672 and notifying him of his due process rights. Tr. at 359; Stip. ¶291; Ex. 66
at 17.
Having received no response, Shrewsbury went to visit Kobus on May 27, 2004. She
found Kobus at home and spoke with him, but Kobus declined a formal interview. Ex. 66 at 1920; see Tr. at 360. During the conversation, Kobus confirmed that Village Turf had a bank
account with Burke & Herbert Bank & Trust Company. He explained that the account had been
closed because the landscaping operation went out of business and he had liquidated all of its
assets. Ex. 66 at 19-20. 13 After the conversation, Shrewsbury asked Burke & Herbert to provide
some of Village Turf’s records. The bank records revealed that, between 1996 and 2003, Village
Turf had funds and that it had written checks for substantial amounts. Ex. 66 at 25; see Ex. 214.
On July 7, 2004, Kobus appealed the penalties for 1996 to 2002. Ex. 66 at 24. On
November 4, 2005, the IRS notified Kobus that his appeal was denied and it was assessing him
with tax penalties under § 6672. Tr. at 365; Stip. ¶292. On October 24, 2006, the IRS assessed
Plaintiff with a penalty for each quarter of 2003. Tr. at 389; Stip. ¶293.
4.
The Loss of Village Turf’s Financial Records
The parties agree that at the time this suit was filed, most of Village Turf’s accounting,
bank, and payroll records had been destroyed. Stip. ¶311. It is undisputed that Village Turf kept
its landscaping records on a computer at the main office, with paper copies of any records stored
in the basement and in a rented storage unit. Village Turf kept the records for its retail store on a
computer at the store and it maintained paper records on the premises as well. Kobus asserts
that, due to several events outside of his control, most of Village Turf’s records were lost or
destroyed between 2004 and 2007. The Court notes that Shrewsbury began investigating Village
Turf in July 2003.
The records from the landscaping business were lost over several years. Kobus testified
that when Village Turf moved to a new office location around 2000, some of Village Turf’s
paper records were lost in the move. Tr. at 136-38. At the new location, Village Turf stored
most of its paper records in the basement, Tr. at 136-38, but it also stored some of its files off
premises in public storage unit, Stip. ¶302. Kobus testified that in 2004 a flood destroyed all of
the paper financial records that were stored in the basement. Tr. at 135-37. In 2006 or 2007, the
paper records that were kept in the storage unit also were destroyed, after Village Turf failed to
pay rent on the unit. Stip. ¶302. Finally, any digital records that existed were destroyed in 2006
or 2007, when Kobus purchased a new computer and discarded the old one from the landscaping
office. Stip. ¶306.
As for the retail store’s records, Kobus asserts that many of those records went missing in
early 2004, around the time that Lagasse resigned. The Government disputes this because
Lagasse testified that all paper and digital records existed when he resigned. In any event, even
13
Shrewsbury’s notes reflect that Kobus told her the landscaping business was out of business but
at another point in the conversation he said that it currently had 3 employees. Ex. 66 at 19-20.
8
if the records still existed in 2004, any records in existence were destroyed in 2005, after Village
Turf failed to pay rent on the retail store and was evicted. Tr. at 138-39. The landlord changed
the locks and did not permit Village Turf to remove anything from the store. Consequently,
Kobus could not recover the store’s computer or the paper records. Stip. ¶310.
While most of Village Turf’s records have been destroyed, the parties were able to
recover a few records from third parties. The evidence in this case includes bank records
supplied by Village Turf’s banks, the tax returns that Village Turf filed, and several financial
statements from 2000, which Village Turf had provided to Southern States.
II.
Discussion
The primary issue in this case is whether Kobus acted willfully. But, as indicated earlier,
there are other ancillary issues involved in this case, namely, (1) burden of proof, (2) the
accuracy of the 2003 estimate, and (3) the impact of the IRS’s sale of Kobus’s house. Deciding
which party bears the burden of proof is analytically prior to the primary issue of willfulness.
Therefore, the Court will first address this issue, then willfulness, and finally issues (2) and (3).
A.
Burden of Proof
The general rule in tax cases is that assessments made by the IRS are presumed to be
correct, and therefore, the taxpayer bears the burden of proof. Danville Plywood Corp. v. United
States, 889 F.2d 3, 7-8 (Fed. Cir. 1990). However, if a tax assessment is found to be “naked,”
lacking in “[a]ny foundation whatsoever,” the presumption of correctness does not apply and the
Government will bear the burden of proof. United States v. Janis, 428 U.S. 433, 441 (1976).
Kobus argues that the Government bears the burden of proving he is liable for all the
penalties, which will require the Government to prove that Kobus acted willfully. According to
Kobus, at the time the IRS assessed him with the penalties, the IRS could not have had sufficient
information to determine whether he had acted willfully. Tr. at 16-17. Because the IRS made
the assessments without having adequate evidentiary support, Kobus argues that the assessments
were naked or arbitrary, and therefore, the Government bears the burden of proof. In the
alternative, Kobus argues that the Government bears the burden of proving he acted willfully in
2001, 2002, and 2003 because the Government is counterclaiming to collect tax balances in those
periods. Ordinarily, the party asserting a claim or a counterclaim bears the burden of proof.
The Government argues that, because IRS decisions are presumed to be valid, Plaintiff
bears the burden of proving that he is not liable by proving that he did not act willfully. The
Government asserts that the assessments are not naked because the IRS’s decision to impose a
penalty is amply supported by the evidence in the record. The Government argues that the IRS’s
determination of willfulness cannot be considered arbitrary or naked because not only did
Shrewsbury thoroughly investigate Village Turf and Kobus, but the IRS Appeals Division
independently examined the evidence and Kobus’s actions as well. The Government argues that
Kobus bears the burden of proof for all of the tax periods at issue because the presumption of
correctness applies to the IRS’s assessments, irrespective of whether it is a claim of
counterclaim.
9
Ordinarily, when a defendant makes a counterclaim, it bears the burden of proof for that
claim. Tax cases, however are different because assessments made by the IRS generally are
presumed to be correct. Danville Plywood, 889 F.2d at 7-8 (stating that the taxpayer carries the
burden of production and the ultimate burden of proof); United States v. Schroeder, 900 F.2d
1144, 1148 (7th Cir. 1990) (same); Ferguson v. United States, 484 F.3d 1068, 1077 (8th Cir.
2007) (stating that “[a]ssessments under § 6672 are ordinarily presumed to be correct”). The
Government can invoke the presumption of correctness by presenting the Certificate of
Assessment, which is prima facie proof that the IRS made a valid assessment. Rocovich v.
United States, 933 F.2d 991, 994 (Fed. Cir. 1991). Accordingly, where the Government presents
a Certificate of Assessment for a tax period, the taxpayer will bear the burden of proving he is
not liable for the assessment. To prevail in a § 6672 case, the taxpayer must establish by a
preponderance of the evidence that the government’s imposition of the penalty against him is
erroneous by proving that he was either not a responsible person or not willful. See, e.g., Mazo
v. United States, 591 F.2d 1151, 1155 (5th Cir. 1979), cert. denied, 444 U.S. 842 (1979);
Brinskele v. United States, 88 Fed. Cl. 334, 339 (2009) (stating that, under § 6672, the plaintiff
bears the burden of proof “both for his own claim and against the government’s counterclaim”).
In some circumstances, however, IRS assessments are not entitled to the presumption of
correctness. The presumption does not apply to assessments that are “naked,” lacking in “[a]ny
foundation whatsoever.” Janis, 428 U.S. at 441. To be naked, an assessment must be
completely unsupported by the evidence before the court such that the assessment is arbitrary
and erroneous. See id. at 442 (“proof that an assessment is utterly without foundation is proof
that it is arbitrary and erroneous”). As the Seventh Circuit explained, for an assessment to be
naked, it “must be more than incorrect”; rather, it must be arbitrary so that the assessment has
“no support and the true amount of tax owed is incapable of being ascertained.” Schroeder, 900
F.2d at 1149; see also Cook v. United States, 46 Fed. Cl. 110, 114-15 (2000) (finding that an
assessment is not naked if it is supported by any admissible evidence in the record, even if that
evidence is different from that originally relied upon by the IRS or is first disclosed in
discovery).
In this case, the Government has established that valid assessments were made because it
has filed the Certificates of Assessments for all of the tax periods at issue. See Rocovich, 933
F.2d at 994 (stating that a “Certificate of Assessments and Payments is routinely used to prove
that a tax assessment has in fact been made” and is “presumptive proof of a valid assessment”).
Therefore, unless Kobus can show the assessments were naked, the IRS’s penalty assessments
are entitled to a presumption of correctness.
The record shows that the IRS began investigating Village Turf and Kobus in July 2003,
and it gave Kobus numerous opportunities to present exculpatory evidence before it initially
assessed him with penalties in May 2004. See Ex. 66 at 1-20. Throughout her investigation,
Shrewsbury made numerous attempts to contact Kobus and to work with him. Despite knowing
that Village Turf had not paid withholding taxes during the preceding 8 years, Kobus made no
attempt at cooperating with the IRS—he provided no information or business records, declined
every interview request, and did not fill out the paperwork to initiate negotiations with the IRS.
With no cooperation from Kobus, Shrewsbury collected what evidence she could by visiting and
10
observing the store, through what bank records she was able to obtain, and from her
conversations with Village Turf’s attorney.
When Shrewsbury recommended that the IRS assess Kobus with the penalties, the
evidence supporting a finding of willfulness was weaker than it is now. Nonetheless, the IRS’s
final determination that Kobus acted willfully was not arbitrary because it was based on
evidence, including Village Turf’s withholding-tax returns showing a balance due, Kobus’s
status as a corporate officer, Shrewsbury’s observations of the store, information from the
attorney, and the bank records; the determination was not lacking in “any foundation
whatsoever.” Even if the evidence was somehow insufficient at the time the IRS assessed the
penalties, the information currently in the record supports the IRS’s determination and the
penalties are neither arbitrary nor erroneous. Because the IRS’s assessments are supported by
evidence in this record, they cannot accurately be characterized as naked.
Kobus actually is arguing that, because he refused to cooperate with the IRS, the IRS had
insufficient information to determine whether he acted willfully and the assessments therefore
were naked. That argument is not persuasive. Nor is the Court persuaded by Kobus’s argument
that he is unfairly prejudiced by the missing financial records. Kobus claims that he was
cooperative with the IRS and argues that he could not provide the IRS with any information
because all of his business records were destroyed or missing. Tr. at 64, 67-68. However,
Kobus knew the IRS was investigating him by October 2003, when he hired Schibani, and he
knew that the IRS had requested Village Turf’s payroll and financial information. At the time,
Village Turf had most of its physical and electronic financial records; it was not until 2004 and
2005 that most of Village Turf’s financial records were lost or destroyed. If Plaintiff had
cooperated with the IRS from the outset, he could have provided the records to the IRS to show
his asserted lack of willfulness.
The Government contends that, because Kobus permitted evidence to be destroyed, it is
entitled to “an adverse inference based on plaintiff’s spoliation of Village Turf’s financial, tax,
and other business records.” Def.’s Memo Fact & Law, at 29. Were the Government to bear the
burden of proof on any elements in this case, the Court would need to decide whether Plaintiff
should be liable for spoliation. 14 In other words, the Court will need to decide the spoliation
issue only if the Government has a need for evidence that has been destroyed. That need will
arise only if Kobus is able to satisfy his burden of proof on the merits. Kobus was on notice of
the impending tax dispute no later than October 2003, and he had an obligation to preserve
evidence. Many of Village Turf’s records were destroyed in 2004 and 2005, after Kobus knew
of the dispute. While the Government has made a good case for spoliation, the Court does not
need to decide the issue at this juncture, because the Court finds that Plaintiff bears the burden of
proof.
14
A party is liable for spoliation if (1) the party controlling the evidence had an obligation to
preserve it; (2) the evidence was destroyed with a “culpable” state of mind; and (3) the evidence was
relevant. The burden of proof for the 3 factors is on the party seeking to use the missing evidence.
Jandreau v. Nicholson, 492 F.3d 1372, 1375 (Fed. Cir. 2007) (describing the “general rules of evidence
law”).
11
The Court finds that the IRS’s determination that Kobus was willful was not arbitrary and
erroneous. The Government has established that the IRS properly assessed Kobus with the
penalties and that the penalties are not naked. Therefore, the IRS’s penalty assessments are
entitled to a presumption of correctness. Accordingly, Kobus bears the burden of proving, by a
preponderance of the evidence, that he did not willfully fail to pay over the withholding taxes.
He bears the burden for both the claims and counterclaims.
B.
Willfulness
The IRS may assess a personal penalty, equal to the amount of the taxes not paid by the
employer, on any person who (1) is required “to collect, truthfully account for, and pay over”
withheld taxes (someone who is a “responsible person”), and who (2) “willfully” fails to collect,
account for, or pay such tax or “willfully” evaded or defeated the tax. 15 § 6672. The “willfully”
requirement essentially is a culpability standard, and a taxpayer will not be made personally
liable for a company’s debt unless he is at “personal fault” for failing to pay the taxes. Slodov,
436 U.S. at 254; Godfrey, 748 F.2d at 1577. On one hand, it is unnecessary for a person to have
a special or fraudulent intent, an evil motive, or bad purpose for his actions to be considered
willful. Godfrey, 748 F.2d at 1577. On the other hand, a person must be more than merely
negligent, and “a person is not ‘willful’ if as a result of negligence he is unaware of the
[nonpayment] of [withholding] taxes.” Bolding v. United States, 565 F.2d 663, 672 (Ct. Cl.
1977). There are two basic ways that a person can willfully fail to pay over withholding taxes: a
person acts willfully if the employer has funds to pay the taxes and the person either (1)
knowingly chooses not to pay over the withholding taxes or (2) acts with a reckless disregard of
a risk that the withholding taxes will not be paid. Godfrey, 748 F.2d at 1577.
First, a person acts willfully if he has actual knowledge of a past or present withholdingtax deficiency and he voluntarily chooses not to pay the United States. 16 Id. at 1576-77; Mazo,
591 F.2d at 1155. More specifically, a person acts willfully as a matter of law if, after he has
actual knowledge of a tax deficiency, he uses unencumbered funds to pay other creditors instead
of the United States. White v. United States, 372 F.2d 513, 522 (Ct. Cl. 1967); Godfrey, 748
F.2d at 1577; Honey v. United States, 963 F.2d 1083, 1090-91 (8th Cir. 1992), cert. denied, 506
U.S. 1028 (1992). A person also acts willfully if “he pays employees their net wages at a time
when the corporation had insufficient funds to cover the taxes thereon” and, when such funds
become available, he prefers subsequent creditors over the United States. White, 372 F.2d at
522. However, a person does not act willfully if the corporation has no funds that can be paid
the government; a person will not be made personally liable for failing to order the impossible.
Godfrey, 748 F.2d at 1577. Nor is a person liable for failing to pay over to the government funds
in which another creditor has a lien or interest that is superior to the government’s interest in the
funds. Slodov, 436 U.S. at 256-58.
15
The parties agree that Kobus was a responsible person.
16
A taxpayer will be liable for an already-incurred deficiency if he was a responsible person both
at the time the deficiency arose and at the time funds are paid to another creditor. See Slodov, 436 U.S. at
245-46. There is no question that Plaintiff was a responsible person during all relevant periods.
12
Second, even in the absence of actual knowledge, a person is liable if he acts with a
reckless disregard of the facts and obvious and known risks that presently-due withholding taxes
are not being paid. Bolding, 565 F.2d at 672, 674; Godfrey, 748 F.2d at 1577. A responsible
person may not “immunize himself from the consequences of his actions by wearing blinders
which will shut out all knowledge of the liability for and the nonpayment of its withholding
taxes.” Bolding, 565 F.2d at 674. For example, a person acts with reckless disregard if he fails
to “investigate or to correct mismanagement after being notified that withholding taxes have not
been duly remitted.” Godfrey, 748 F.2d at 1578 (quoting Mazo, 591 F.2d 1151).
Kobus’s main argument is that he was merely negligent in mismanaging Village Turf and
his actions do not rise to the level of willful. He claims that he never had actual knowledge that
Village Turf was not remitting its withholding taxes because he did not keep track of Village
Turf’s financial affairs. Kobus claims that when he finally learned about the withholding-tax
deficiencies in 2002, Village Turf had financial problems and all of its funds were encumbered
by security agreements with creditors. He asserts that § 6672 does not make a responsible
person a guarantor, and he should not be personally liable for Village Turf’s debt because it had
no money to pay the taxes.
The Government contends that Kobus knew or should have known that Village Turf was
not remitting its withholding taxes. The Government asserts that Kobus either knowingly or
recklessly failed to re-delegate the duty to prepare and remit taxes when Woods left in 1997.
Accordingly, the Government asserts that Kobus is liable from 1997 forward. The Government
also argues that Plaintiff incurred liability for tax periods 1996 to 2001 when Village Turf filed
the delinquent withholding-tax returns in April 2002. Subsequently, Kobus had actual
knowledge of the tax deficiencies and he permitted Village Turf to pay substantial sums to other
creditors instead of using those funds to satisfy the tax deficiencies.
Kobus also advances several other arguments for why he should not be liable for the
penalties. He claims that, in recognition of his lack of business knowledge, he delegated the duty
to pay taxes to Lagasse in 2001 or 2002. He claims he had no reason to think that Lagasse would
not pay the taxes, and therefore, his delegation of tax matters to Lagasse should absolve him
from responsibility for the unpaid taxes. Kobus also argues that the “willfulness” standard is a
tort-like standard, and therefore, the Government should be held to some standard of care. He
argues that even if he was negligent, the Government also was negligent because it did not try to
collect on the 1996 to 2001 deficiencies until 2003.
In response, the Government argues that, even though Kobus hired Lagasse to manage
the retail store in 2001, Kobus did not delegate the duty to pay all of Village Turf’s taxes to
Lagasse. It maintains that, even if Kobus did delegate the duty to Lagasse, Kobus is liable for
the 2001, 2002, and 2003 taxes because the withholding-tax returns Village Turf filed in 2002
provided notice to Kobus that Lagasse was not paying the taxes and Kobus took no action to
correct the problem. Finally, the Government argues that Plaintiff’s negligence theory is actually
a laches theory, and it is well-settled that laches does not apply to the Government. Closing Arg.
Tr. at 58.
13
For the reasons that follow, the Court finds that Kobus willfully failed to pay over the
withholding taxes to the Government for all tax periods at issue. For the purposes of analysis,
the Court has divided the relevant time periods into 3 groups based on Village Turf’s
administrative employees: during Woods’s tenure, from 1996 to March 1997; during Clay’s
tenure, from March 1997 to June 2001; and during Clay’s and Lagasse’s joint tenure, from June
2001 through Q4 2003.
1.
From 1996 to March 1997 – While Woods Was Responsible for
Preparing the Payroll
The parties agree that Village Turf remitted most of its withholding taxes in 1996, but it
missed a few payments for that tax year. Village Turf deposited $39,556, but left an unpaid
withholding-tax balance of $5,745. Stip. ¶199. At the time, Kobus had delegated the duty to pay
taxes to Woods, and he had no reason to suspect that withholding taxes were not being paid. The
Court finds that in 1996, Kobus lacked actual knowledge that Village Turf was not remitting its
withholding taxes and he reasonably had delegated the duty to pay withholding taxes. Therefore,
the Court finds that Kobus did not willfully fail to pay the taxes in 1996.
Nonetheless, Kobus is liable for the 1996 tax penalty 17 if, after he learned about the
deficiency, he knowingly and voluntarily paid unencumbered funds to other creditors instead of
paying the IRS. White, 372 F.2d at 522; see Honey, 963 F.2d at 1087 (stating that if a taxpayer
had “knowledge of payments to other creditors, including employees, after he was aware of the
failure to pay over withholding taxes is proof of willfulness as a matter of law” (quoting Olsen v.
United States, 952 F.2d 236, 240 (8th Cir. 1991))). However, Kobus will not be liable for the
non-payment if Village Turf did not have funds it could have used to pay the taxes.
Kobus stipulated that he knew about the 1996 tax deficiencies by April 2002 when
Village Turf filed the delinquent return. He also stipulated that Village Turf paid out at least
$500,000 in 2002 18 and at least $400,000 in 2003. Stip. ¶¶144, 148. These payments are
exclusive of any payments made to Southern States or any other secured creditor. Thus, unless
the funds paid to the other creditors were encumbered, Village Turf had funds it could have used
to pay the tax deficiency but Kobus knowingly and voluntarily chose to pay other creditors
instead.
The terms “encumbered” and “unencumbered” have not been defined by the Supreme
Court or the Federal Circuit in this context. The Eighth Circuit has described encumbered funds
as: “Where the taxpayer’s discretion in the use of funds is subject to restrictions imposed by a
creditor holding a security interest in the funds which is superior to any interest claimed by the
17
Though the Court is referring to the 1996 tax period, this analysis applies to January to March
of 1997 as well.
18
It is not clear from the record when in 2002 the funds were spent, and it is likely that some
were spent before April. However, Village Turf was a seasonal business and most of its expenses likely
occurred during Q2 and Q3 2002, which were the busy months. For example, Village Turf paid out
$101,711 in wages in Q2 2002 (April 1 to June 30), Stip. ¶¶256, 261; and $96,482 in Q3 2002 (July 1 to
September 30), Stip. ¶¶267, 272. See also Ex. 52.
14
IRS, the funds are regarded as encumbered if those restrictions preclude the taxpayer from using
the funds to pay the trust fund taxes.” Honey, 963 F.2d at 1090 (quoting In re Premo, 116 B.R.
515 (Bankr. E.D. Mich. 1990)). Several other circuits have adopted the Eighth Circuit’s
definition. See United States v. Kim, 111 F.3d 1351, 1359 (7th Cir. 1997); Barnett v. Internal
Rev. Serv., 988 F.2d 1449, 1458 (5th Cir. 1993). The Court is persuaded that the Honey
definition is consistent with both the purpose of § 6672 and Federal Circuit precedent; personal
liability will attach only when the employer had funds that could have been paid to the IRS and
the taxpayer chose not to pay the IRS.
Kobus claims that after he opened the retail store, all of Village Turf’s funds were
encumbered by UCC security agreements with Southern States and other creditors. Kobus
asserts that the security agreements covered all of Village Turf’s bank accounts 19 and all of the
proceeds it earned from sales. Pl.’s Memo Fact & Law, at 9; Closing Arg. Tr. at 22. Therefore,
Kobus argues, every dollar of revenue was encumbered by a security agreement and he could not
have paid the withholding taxes. Kobus admits that he paid other creditors, but he asserts that is
not evidence that some of the funds were unencumbered; rather he claims that he improperly was
making payments with encumbered funds. Pl.’s Memo Fact & Law, at 9.
The Government contends that despite the seemingly broad language of the security
agreements, 20 Village Turf’s creditors permitted the company to use the proceeds from sales of
inventory to satisfy ordinary business expenses, such as paying wages and rent. It argues that the
Court should look to the practice of the parties under the agreements and not solely to the
language of the agreement itself. It also argues that Kobus admits that Village Turf used
proceeds to pay ordinary business expenses, and Kobus’s voluntary payment of other creditors is
evidence that the funds were unencumbered.
Although a pre-existing, perfected security interest in collateral, such as inventory,
generally is superior to the IRS’s interest, Slodov, 436 U.S. at 257, blanket security agreements
do not necessarily preclude the debtor from using cash proceeds from the sale of inventory to pay
tax obligations, see Honey, 963 F.2d at 1092 (finding that the secured party had an interest in
proceeds the debtor received from the sale of inventory that was superior to the IRS’s interest but
that the security agreement did not restrict debtor’s use of the funds); Kim, 111 F.3d at 1361
(same). Here, Village Turf’s funds will be considered encumbered only if Southern States put
restrictions on Village Turf’s use of the proceeds from the sale of inventory that precluded it
from using the funds to pay for taxes.
19
Between 2001 and 2003, Village Turf maintained separate bank accounts for the landscaping
and retail operations. Stip. ¶95. While the bank account for the retail store may have been subject to the
security interests, Village Turf’s account at Burke & Herbert was used exclusively for its landscaping
operations and would not have been subject to the security interests. Therefore, any funds in the Burke &
Herbert account would have been unencumbered.
20
For example, the security agreement with Southern States provided: that Village Turf granted
Southern States a “security under the Uniform Commercial Code” in “[a]ll accounts and inventory at any
time hereafter acquired” and in “[a]ll proceeds of such accounts . . . and inventory.” Ex. 78.
15
The record shows that, during the time when Kobus alleges all his funds were
encumbered, Village Turf was paying substantial sums to other creditors. For example, in 2002,
Village Turf paid $325,997 in wages, $8,862 in repairs and maintenance, $31,236 in advertising,
$30,956 in insurance, and $5,466 in supplies. Stip. ¶144. At no time did its creditors tell Village
Turf that it could not use its revenues to pay for business expenses. See Tr. at 442-44.
Moreover, the creditors must have contemplated payment of revenues to other entities because
the agreements specifically required Village Turf to pay any taxes or levies incurred on inventory
and to purchase insurance for the inventory. Ex. 78. As a matter of logic, it would make no
sense for Village Turf’s creditors to forbid it from using revenues to pay for operating expenses;
if they did, the company would have no funds that could be used to rent a store, pay wages, or
pay any other bills, and it would impossible to actually run the business. The Court finds that the
security agreements did not preclude Village Turf from using funds to satisfy ordinary business
expenses such as wages, taxes, and insurance.
The Court finds that Kobus has not proven that Village Turf’s financial assets were
encumbered such that he had no discretion to pay the withholding-tax liability out of the store’s
revenues. See Honey, 963 F.2d at 1090-91 (taxpayers had burden of proving all funds in an
account were proceeds from sale of inventory and therefore encumbered by security interests).
The parties have stipulated that Village Turf paid to other creditors at least $500,000 in 2002 and
at least $400,000 in 2003. Stip. ¶¶144, 148. The Court finds that those funds were
unencumbered because Village Turf had discretion to use those funds to pay its operating
expenses.
The Court finds that after Kobus knew about the 1996 tax deficiency in April 2002,
Village Turf had unencumbered funds available and Kobus chose to use those funds to pay other
creditors instead of the Government. Therefore, Kobus willfully failed to pay Village Turf’s
withholding taxes for 1996, and he is liable for the penalty.
2.
From March 1997 to June 2001 – While Clay Was Responsible for
Preparing Payroll
It is undisputed that, up until March 1997, Plaintiff had delegated the duty to pay
withholding taxes to Woods, and Village Turf was filing the appropriate returns and remitting
most of the taxes. In March 1997, however, Village Turf stopped making its withholding-tax
deposits altogether, and it never resumed making them. It also stopped filing its withholding-tax
returns, an oversight it did not correct until 2002. The parties stipulated that, after Woods retired
in early 1997, Plaintiff did not re-delegate the duty to remit withholding taxes or to prepare the
withholding-tax returns. Plaintiff explained that he assumed that new personnel were doing the
same tasks as former personnel and he did not exercise any supervision over his office staff. Tr.
at 26-29.
Plaintiff urges the Court to find that his mismanagement of Village Turf was merely
negligent. Kobus claims he was preoccupied with the operations side of the business and he
overlooked reassigning the duty to handle payroll and withholding taxes. Kobus admits he
should have supervised his office staff, but asserts that being a bad business manager does not
make him culpable and liable for the penalty.
16
The Court cannot accept Plaintiff’s argument. Kobus characterizes his mistake as
innocent mismanagement of a business. But, beyond failing to delegate office tasks or making
bad business decisions, Kobus claims he was completely oblivious of the company’s expenses
and financial situation. Kobus was the company’s sole owner and had invested substantial sums
of money in the business. See Pl.’s Memo of Fact & Law, at 7; Ex. 45 at 4. He also asserts that
as early as 1997 the company was in financial trouble. Tr. at 132-33. Nonetheless, he claims he
did not read the checks he signed, he did not review financial statements, and he did not exercise
any oversight over his employees. Although Kobus did not have a background in business, his
experience in the Marine Corps included managing multi-million dollar annual budgets,
preparing 5-year budgets, and overseeing a large number of personnel. Stip. ¶6. Given the
circumstances, the Court has trouble crediting Kobus’s assertions that he was completely
ignorant about his company’s finances, expenses, and tax obligations.
After Woods left Village Turf, there were many warning signs that something was wrong
with the company’s finances. First, Village Turf stopped making periodic withholding-tax
deposits. Between February 5, 1996 and March 28, 1997, Village Turf made 16 tax deposits 21
with the IRS, totaling $55,000, which were paid by checks signed by Plaintiff. Stip. ¶¶162-64.
Frequently, Village Turf’s total tax deposits exceeded $5,000 in a month. Exs. 1-3. For
example, in March 1997, the last month that Village Turf made a tax deposit, Village Turf
remitted two deposits which totaled $9,464.04. Stip. ¶50.
When Village Turf stopped making the deposits, Plaintiff would have stopped signing a
large, recurring check. Kobus testified that his failure to notice this change was merely negligent
and explained that he was not focused on office tasks and often did not read the documents he
signed. Even if signing payroll checks was an administrative duty to which he did not pay much
attention, it is difficult to believe that Kobus did not notice the absence of a large check each
period. In 1997, Kobus was Village Turf’s only corporate officer and the only person with
check-signing authority. The Court finds it incredible that Kobus would not have noticed the
elimination of such a large, recurring expense. Kobus cannot avoid responsibility for his
obligations by adopting a practice of signing documents without reading them, so that he would
not have noticed whether or not a recurring check ceased to be presented for his signature. See
Bolding, 565 F.2d at 673-74 (finding that the responsible person should be charged with
knowledge of non-payment in part because he was not asked to sign or countersign checks for
payroll tax deposits). 22
21
Those payments were allocated to the 1995, 1996, and 1997 tax periods. Stip. ¶162. The
payments included both the employer and employee FICA taxes.
22
See also Fraass Surgical Mfg. Co. v. United States, 571 F.2d 34, 40 (Ct. Cl. 1978) (finding that
a contract clause was enforceable and calling the testimony of the plaintiff corporation’s president that he
did not read the contract “irrelevant and unacceptable” and stating that “an experienced businessman . . .
should know better”); Upton v. Tribilcock, 91 U.S. 45, 50 (1875) (stating “[i]t will not do for a man to
enter into a contract, and, when called upon to respond to its obligations, to say that he did not read it
when he signed it, or did not know what it contained”).
17
Second, Village Turf stopped filing its annual withholding-tax returns. Kobus was the
sole corporate officer at this time and was responsible for ensuring that the corporation complies
with its duties. He should have noticed that he no longer was signing and filing a withholdingtax return. As before, Kobus cannot excuse his failure to notice the missing tax returns by
arguing that he never read the documents he signed.
Third, after Village Turf stopped remitting the withholding taxes, it would have had a
substantial increase in available revenue. For tax year 1996, Village Turf’s tax deposits totaled
$39,556, Stip. ¶199, and its total revenue was $414,000, Ex. 45. Thus, Village Turf’s tax
deposits in 1996 comprised nearly 10% of its total revenue. Kobus testified that he did not
notice the increase in revenue because the business was “struggling” at that time. Tr. at 132-33.
Rather than explain his failure to notice the change, that the business was having trouble makes it
all the more suspicious; a business owner who is experiencing trouble is more likely to scrutinize
financial records to see why he is losing money or to find ways to save on expenses. Although
most of the relevant financial records have been destroyed, the records that do exist indicate that
the financial statements showed a discrepancy in the amount of withholding taxes owed. Ex. 88
(year 2000 balance sheet showing federal withholding taxes payable of $19,098); Ex. 89 at 4
(year 2000 profit and loss statement showing a profit of $74.64 on FICA taxes). Had Kobus
looked at the financial statements, he would have noticed a problem.
Finally, after Woods left, the payroll duties were taken up by Clay. Clay admitted that
she prepared the payroll, but testified that it was never her duty to pay taxes. Tr. at 209-12.
Although Plaintiff stipulated that no one was responsible for paying withholding taxes because
he never re-delegated the duty to pay them, Plaintiff testified at trial that he delegated the duty to
pay withholding taxes to Clay. Whatever the precise scope of duties that Kobus assigned to
Clay, the record shows that between March 1997 and June 2001 Clay was the only person who
was responsible for the payroll. Kobus testified that he did not train Clay and that he did not
exercise any oversight over her. At the time, Clay had no legal obligations to the company
because she was never an employee and she was not made a corporate officer until May 2000.
Had Kobus exercised any supervision over Clay’s performance of her duties, he would have
noticed that withholding taxes were not being paid. Kobus, who for several years had been
collecting and remitting withholding taxes, would have known that the preparation of payroll
necessarily entails tax issues even if he did not know precisely what those issues were. The
Court does not agree that it is mere negligence to entrust payroll duties to a non-employee
without exercising any supervision over the person.
It seems unlikely that Kobus could have been so oblivious to Village Turf’s finances that
he would not have known that Village Turf was not remitting its withholding taxes, and the
Court finds that Kobus more likely than not knew what was going on. But even if the Court
were to credit his testimony that he had no idea what was going on, it would find that Kobus
deliberately disregarded an obvious risk that taxes would not be paid by completely ignoring the
financial side of the business. Kobus, who was Village Turf’s sole corporate officer until 2000,
cannot immunize himself from liability through a “deliberate or reckless disregard of the facts
and known risks . . . .” Bolding, 565 F.2d at 674; see Teets v. United States, 29 Fed. Cl. 697, 712
(1993) (holding that a responsible person’s “ignorance does not relieve him from liability.
Certainly, if he did not know, he should have known.”).
18
The Court finds that Kobus knew Village Turf was not remitting its withholding taxes in
1997. Kobus took no corrective actions until June 2001, when Kobus allegedly delegated the
duty to pay taxes to Lagasse. Therefore, if Village Turf had funds available that could have been
used to pay creditors, Kobus will be liable for the penalty. The record shows, and the parties
agree, that between 1997 and 2001 Village Turf paid funds to other creditors well in excess of its
withholding-tax liabilities 23 for those periods. Stip. ¶¶62-76. Accordingly, the Court concludes
that Kobus willfully failed to pay over the withholding taxes from March 1997 to June 2001, and
it finds that he is liable for the penalties for those time periods.
3.
From June 2001 to 2003 – While Both Clay and Lagasse Had Payroll
Preparation Duties
Village Turf opened the retail store in June 2001. Kobus asserts that he should not be
liable for the penalties incurred by the store because he had delegated the duty to pay the retail
store’s taxes to Lagasse. 24 Kobus argues that it was reasonable to assume that a trained business
professional would perform the duties assigned, and he had no reason to suspect that Lagasse
was not paying the store’s withholding taxes. Pl.’s Memo Fact & Law, at 6-7. Kobus claims
that Lagasse had full authority to pay all withholding taxes as they came due, Tr. at 37-39, and
that Lagasse never mentioned any withholding tax deficiencies to him, Tr. at 50-51, 54. Kobus
also continues to argue that he should not be liable for any deficiency incurred by the
landscaping business because he did not know that no one was paying those withholding taxes.
Kobus maintains that when he asked Lagasse to investigate Village Turf’s tax problem,
Lagasse took over the duty to pay both the past deficiencies and the presently-due withholding
taxes incurred by the landscaping operation. Kobus testified that he turned the whole problem
over to Lagasse and he did not exercise much oversight over Lagasse’s handling of the situation.
Tr. at 61-62, 169. Kobus testified that he occasionally checked up on the issue by asking
Lagasse about the status of negotiating a plan with the IRS, but that Lagasse always told him he
would have a solution soon. Then, Lagasse resigned. Tr. at 50-52.
Kobus appears to assert that part of the reason he hired Lagasse in 2001 was to take care
of Village Turf’s tax problem. Pl.’s Memo Fact & Law, at 6; Closing Arg. Tr. at 5-6. However,
Kobus also claims that he did not know about the tax problem until 2002. Kobus backed away
from his assertion at trial when he testified that, although he had Lagasse help him with some
financial issues before the store opened, he did not think the issues were tax related. Tr. at 11921. Kobus also tried to back away from his admission that he knew about the tax deficiencies in
April 2002, see Closing Arg. Tr. at 44; Kobus testified that, while he knew Village Turf had a tax
problem in 2002, he did not necessarily know that the withholding taxes were not being paid
23
According to the withholding-tax returns, the unpaid withholding taxes were $150,279. See
Exs. 26-31. Between 1997 and 2001, Village Turf paid out many hundreds of thousands of dollars which
included wages, maintenance, rent, supplies, insurance, and advertising. See Stip. ¶¶65-76.
24
Kobus seems to assert that it was Lagasse’s duty to pay taxes for both the landscaping
operations and the retail store, but his testimony was unclear.
19
because he did not read the withholding-tax returns that Village Turf filed. Tr. at 163-70. Kobus
had stipulated, however, that he knew that Village Turf had unpaid withholding-tax liabilities on
April 14, 2002, when Village Turf filed the tax returns for 1996 to 2001. Stip. ¶178 (“On
4/14/2002, . . . Kobus knew that Village Turf had unpaid employment tax liabilities to the IRS
for each of [the tax years 1996 to 2001]”).
Kobus’s testimony was unclear on a number of issues because it frequently contained
exchanges such as the following excerpt from his cross-examination.
Q
Did you delegate to Mr. Lagasse the responsibility of filing Village Turf’s
employment tax returns from the date you gave him the [fix-the-tax-problems] job
until the day he left the company?
A
I would think that as Dan [Lagasse] went through and had talks,
supposedly talked with the IRS and the state and our creditors, that he came up
with a plan and if he needed to do some filing, he would have brought that to my
attention.
Q
Did you tell him that it was his job to file those returns?
A
I told him he had the authority to file those returns if he had to refile them.
Q
Did you tell him it was his responsibility to file the returns?
A
Did I put it in writing with his name on it and hand it to him? No. You’re
absolutely right, I didn’t do that.
Q
That’s not what I asked. I asked did you tell him that it was his
responsibility to file the returns?
A
No, not in so many words.
Q
Did you tell Mr. Lagasse that it was his responsibility to pay federal tax
deposits on all future tax periods to the IRS in connection with payroll obligations
of Village Turf?
A
Yes, when it came to the store.
Q
It was his responsibility for the store?
A
Oh, yeah.
Tr. at 167-68.
In contrast, Lagasse testified that he had a much more limited scope of duties and that
Kobus retained significant authority over the retail store’s financial affairs. Lagasse testified that
20
he was hired to run the retail store, and his duties did not encompass taking care of taxes for the
landscaping business. Tr. at 421-24. Lagasse testified that, while he had authority to sign
payroll checks and to pay rent, he had to get Kobus’s permission before paying any other bills.
Tr. at 436-38. He testified that he set up the store’s accounting systems and that initially some of
the taxes automatically were sent to either the state or the IRS. Tr. at 429. He testified that
Kobus asked him to stop automatically remitting the taxes so that both the store and landscaping
bills could be processed centrally. Tr. at 429-31. He also testified that the accounting software
automatically calculated the withholding taxes and it generated reports that would show the
balances. Tr. at 427-29.
Lagasse testified that the store always had trouble paying bills because Kobus only gave
the store $5,000 in operating capital. Tr. at 437. Lagasse testified that he would have weekly or
biweekly meetings with Kobus, where he would present Kobus with a list of accounts payable
and accounts receivable. Kobus would go through the list of bills and decide which would get
paid. Tr. at 436-40; Tr. at 463-66. Due to cash constraints, many bills were not immediately
paid. Lagasse testified that his monthly reports showed the withholding-tax liabilities, and he
repeatedly asked Kobus about whether Village Turf was paying these taxes. Tr. at 463-66. He
testified that Kobus always told him not worry about the perceived problem because Kobus or
Clay25 was taking care of it. Tr. at 463-66, 487-88.
Lagasse admitted that, in 2002, he helped Kobus investigate the withholding tax
problems and that he prepared the withholding-tax returns for 1996 to 2001. He testified that he
helped with the tax problem because Kobus asked him to, but it ordinarily was not his job to
handle Village Turf’s taxes. Tr. 444-46, 451-52.
The Court finds Lagasse’s testimony to be credible. His testimony was internally
consistent. Based on Lagasse’s demeanor, it is the Court’s impression that Lagasse testified
honestly and to the best of his recollection. This is in contrast to Kobus’s evasive testimony,
which at times was ambiguous and contradictory. On several occasions, Kobus would not admit
to facts that he had stipulated were true.
The Court finds that Plaintiff did not delegate the duty to pay taxes to Lagasse. The
Court credits Lagasse’s testimony that he brought the unpaid taxes to Kobus’s attention and
Kobus told him not to worry about it because it was being taken care of. The Court finds that
Plaintiff retained control over the payment of bills and he did not permit Lagasse to pay the taxes
without getting approval first. Therefore, the Court finds that Kobus knew in 2001 that the
withholding taxes were not being paid and he knowingly chose not to pay over the withheld
taxes to the Government.
Moreover, even if the Court were to credit Kobus’s testimony and find that Kobus
delegated to Lagasse the duty to pay all of Village Turf’s taxes, Kobus still would be liable for
the penalties. Kobus hired Lagasse in 2001. By April 2002, Kobus knew that Village Turf did
not pay its withholding taxes in 2001. If Kobus reasonably had delegated the duty to pay taxes
to Lagasse in 2001, Kobus recklessly failed to start supervising Lagasse in April 2002, after
25
At this time, Clay still was taking care of any payroll for the landscaping operations.
21
Kobus learned that the 2001 taxes were not paid. At that point, he had a duty to correct
Lagasse’s mismanagement and to exercise some oversight to ensure that the taxes were paid.
Godfrey, 748 F.2d at 1578; see Mazo, 591 F.2d at 1157 (finding that, after a corporate official
had actual notice of a deficiency, the official could not escape liability by delegating his
responsibility to a subordinate). Kobus did not do so, and therefore, he knowingly or recklessly
failed to remit the taxes.
As discussed above, Village Turf paid to non-secured creditors over $500,000 in 2002
and over $400,000 in 2003. The Court finds that, between 2001 and 2003, Village Turf had
unencumbered funds that it could have used to pay the tax deficiencies. Therefore, the Court
finds that Kobus knowingly paid other creditors in preference to the United States, and he
willfully failed to pay over withholding taxes from June 2001 through 2003. Accordingly,
Kobus is liable for the penalties for those periods.
4.
The IRS’s Negligence and Duty to Mitigate Damages
Before concluding its discussion of willfulness, the Court must address the other
arguments made by Plaintiff. In his answer to the Government’s counterclaims, Kobus asserts
that the Government’s claims are barred by laches. Pl.’s Am. Answer ¶32. In his briefings and
oral arguments, Kobus admits that laches generally is not available against the United States.
Pl.’s Memo Fact & Law, at 8. Instead, Kobus argues that the willfulness standard is a tort-like
standard and therefore the Government should be held to a reasonable standard of care in
initiating tax collection efforts. Id. at 4-5, 8; Closing Arg. Tr. at 8-9. According to Kobus, “The
facts in this case are quite analogous to the defense of contributory negligence.” Pl.’s Memo
Fact & Law, at 8. Had the Government taken enforcement actions sooner, Village Turf would
have corrected its mistake without incurring such a large tax balance. Id. at 8-9. He asserts that
the Government “needs to take responsibility for its inattention to the situation at Village Turf,
Inc., as well.” Id. at 5.
The Government raises several arguments against Kobus’s theory. The Government first
asserts that no inequity results by holding Kobus responsible for his willful failure to comply
with the law. Def.’s Memo Fact & Law, at 17-18. Next, the Government argues that there is no
authority for Kobus’s contributory negligence defense. Finally, the Government asserts that
Kobus’s argument is actually a laches argument because he is claiming “that it would be
inequitable, as a result of undue delay, for the Government to enforce the [withholding tax]
penalties.” Id. at 18.
The Court finds that Kobus has advanced no meritorious basis for grafting a contributory
negligence defense onto the willfulness standard under § 6672 and the Court perceives no reason
to adopt such a defense in general. The Court also finds that it is not inequitable to hold Kobus
responsible for the tax penalties, especially when the IRS acted within the statutorily provided
time frame. The IRS generally must assess a tax within 3 years after the return was filed, 26
U.S.C. § 6501(a), but when a taxpayer fails to file a return, the tax may be assessed at any time, §
6501(c)(3). Village Turf filed returns for 1996 to 2001 in April 2002, and the IRS notified
Village Turf of the delinquent taxes in May 2002. In May 2004, the IRS notified Kobus that he
was being assessed with the personal penalties for 1996 to 2001 and Q2 and Q3 of 2002. Village
22
Turf never filed withholding-tax returns for any quarter of 2003, and the IRS assessed Kobus
with personal penalties in 2006. Kobus has not identified any inequitable conduct or delay by
the IRS.
Kobus advances another equitable theory in his closing argument. He asserts that the
Government has a duty to mitigate its damages, citing to Ketchikan Pulp Co. v. United States, 20
Cl. Ct. 164 (1990). Closing Arg. Tr. at 49. He asserts that the IRS knew of Village Turf’s
failure to pay taxes for 5 years before it took any action to collect. Id. In closing, he recognizes
that many of his equitable theories were not raised in a pleading and he requests that the
pleadings be amended to conform to the evidence. Id. at 50-51.
The Government admits that the Government has a duty to mitigate damages in contract
actions, but asserts that the fact that a contracting party has a duty to mitigate damages does not
mean that the Government has a duty to mitigate damages in actions that do not arise under
contract law. Id. at 58-59. It also objects to Kobus’s request to amend the pleadings. Id. at 50.
The Court is not persuaded that the IRS must mitigate its damages. Ketchikan Pulp,
which is a decision by another Court of Federal Claims judge, is not binding on this Court. Even
if it were, Ketchikan Pulp is inapposite to this case because it was a breach of contract case and
has no relation to the tax matters at issue here. 26 The Court also denies Kobus’s request to
amend the pleadings. Not only are his equitable theories lacking merit, but the Court finds no
basis to grant his post-trial request.
C.
The Amounts of the 2003 Assessments
The parties agree that the amounts of the assessments for 1996 to 2001 and for Q2 and
Q3 of 2002, which were based on the withholding-tax returns that Village Turf filed, are
accurate. Kobus asserts, however, that the 2003 penalty amounts are inaccurate and “arbitrary
and capricious.” Pl.’s Am. Answer ¶31.
Village Turf did not file any withholding-tax returns for 2003, so Shrewsbury estimated
Village Turf’s 2003 liability and prepared substitute returns pursuant to IRS procedure. Tr. at
380-85; see 26 U.S.C. § 6020. Shrewsbury based her estimates on the numbers reported in
Village Turf’s Q2 2002 withholding-tax return. She estimated that, in all 4 quarters of 2003,
Village Turf had the same wages as in Q2 of 2002, resulting in an annual wage estimate of
$481,352.23. Stip. ¶¶282-84; Tr. at 382-84. She then estimated Village Turf’s FICA liability
and federal income tax withholding liability, using 20% as the tax withholding level. Tr. at 38486; see Ex. 68 at 26-27. This brought Village Turf’s total withholding-tax deficiency to
approximately $130,000 for 2003. See Stip. ¶¶284-86.
26
In Ketchikan Pulp the Court stated that Government had “a duty to mitigate its damages when a
purchaser or seller breaches its contract” and it found that the Government in that case properly sold
timber to another purchaser to offset the damages incurred when the original purchaser backed out.
Ketchikan Pulp, 20 Cl. Ct. at 166-67.
23
Kobus argues that the Government bears the burden of proving the accuracy of the
amounts of the 2003 penalty assessments because the penalties were based on estimates. He
maintains that the assessments should be adjusted down based on the wages reported in Village
Turf’s 2003 Form 1120S, its corporate income-tax return. Kobus asserts that if the estimates
were based on the more accurate numbers from the Form 1120S, Village Turf’s total tax liability
for 2003 would be $46,899.39. Pl.’s Memo Fact & Law, at 11. He also asserts that the IRS
should have looked to the W-2s to get more accurate wage information.
The Government admits that the assessments were based on Shrewsbury’s estimates, but
asserts that the penalty amounts are presumptively valid because the method for making the
estimates was reasonable and logical. The estimates were calculated using the methodologies
contained in the IRS’s field manual. Tr. at 382-86, 390; Stip. ¶¶282-85. Because the amounts
are presumptively correct, the Government claims that Plaintiff bears the burden of proving that
the amounts are incorrect and of proving the correct amounts. The Government also argues that
the 2003 Form 1120S, which was filed on November 16, 2006, see Ex. 53, is not a reliable
source for Village Turf’s wages because the IRS had assessed Kobus with the 2003 tax penalties
on October 24, 2006. It also notes that the IRS does not get access to the W-2s, which are filed
with the Social Security Administration (“SSA”), until years after the forms are processed.
When a taxpayer does not maintain adequate records, the IRS can estimate the taxpayer’s
liability. The presumption of correctness applies to all properly made assessments, including
estimates, because if it did not, taxpayers could defeat any assessment by not maintaining proper
records. Judge Firestone notes in Brinskele, “where the IRS estimates a tax liability because the
taxpayer has failed to maintain adequate records . . . courts have uniformly rejected challenges to
the presumption of correctness associated with the IRS assessment.” 88 Fed. Cl. at 339. The
Eighth Circuit has stated that, even if an assessment is an estimate, the presumption applies if
“the method for making the estimate is reasonable and logical.” Ferguson, 484 F.3d at 1077.
Similarly, the Seventh Circuit has found that “[w]hen a court is faced with an incorrect but
otherwise valid assessment the proper course is not to void the assessment . . . but to determine
what, if anything, the taxpayer owes the government.” Schroeder, 900 F.2d at 1148.
In this case, while the IRS based the estimates on limited information, the estimates were
not arbitrary and its actions were reasonable and lawful. The IRS did not have more information
because Village Turf did not file a withholding-tax return or a timely income-tax return. Nor did
Kobus cooperate in the investigation by providing information or business records. The Court
agrees with the approach taken by other circuits, and a taxpayer “who cannot produce adequate
records may not complain of the inevitable inaccuracies in assessment their default occasions.”
Fergusson, 484 F.3d at 1077-78 (quoting Caulfield v. Comm’r, 33 F.3d 991, 993-94 (8th Cir.
1994)); see Brinskele, 88 Fed. Cl. at 339. Therefore, the assessments are presumptively correct
unless Kobus can prove by a preponderance of the evidence that they are wrong.
The Court finds that Kobus has not presented sufficient evidence for the Court to
determine whether his actual withholding-tax deficiencies for 2003 are lower than the assessed
amounts. Kobus asserts that the estimates are high, and points to Village Turf’s 2003 Form
1120S and the W-2s of its employees. The Form 1120S, however, was filed after Kobus had
notice of this dispute. It is not clear when the W-2s were filed, but Village Turf did not always
24
file all of its W-2s, 27 so the Court is not convinced that the 2003 W-2s represent all of Village
Turf’s wages for that year.
The Court notes that it is troubled by the amounts of the 2003 penalties, which amount to
$33,273.17 per quarter or over $130,000 for the year. In 2002, Village Turf’s withholding tax
liability was $20,075 for Q2 and $19,513 for Q3, or under $40,000 for the year. Stip. ¶¶261,
272. In 2001, its total withholding-tax liability was $75,473. 28 Stip. ¶251. Shrewsbury’s
estimate was made on the assumption, per IRS manual procedure, that Village Turf’s employees
had 20% of their income withheld for federal income taxes. In prior years, Village Turf’s
income-tax withholding level was less than 10%. See Exs. 26-31; Stip. ¶¶204-50. Shrewsbury’s
assumption that Village Turf had a withholding level of 20% seems to have inflated Village
Turf’s tax liability for 2003 to be greater than in any other year.
It seems plausible that the 2003 penalty assessments are higher than the actual amounts of
unpaid withholding taxes. The parties stipulated that in 2003 Village Turf paid out at least
$259,948 in wages, Stip. ¶148, although the Government asserts the wages could have been
higher. Given the absence of any reliable evidence of Village Turf’s 2003 wages, the Court
cannot say that Kobus has proven by a preponderance of the evidence that the 2003 estimates
were wrong. The Court speculates that a more accurate amount might be calculated by adjusting
the income-tax withholding level to its historic level of around 10%. However, the record
contains insufficient evidence due to the destruction of Village Turf’s records for the Court to
reach that conclusion.
The Court’s conclusion is colored by the Government’s assertion that Plaintiff permitted
evidence to be destroyed. Between 2004 and 2006, most of Village Turf’s paper records were
destroyed and its electronic records were deleted. Were the record to contain some evidence in
Plaintiff’s favor on the proper amounts of the assessments, the Court would need to decide
whether Plaintiff should be liable for spoliation. Had Village Turf retained all of its records, the
Government could have had evidence to rebut Kobus’s claims. As discussed supra, Kobus was
aware of the IRS’s investigation by October 2003, and he had an obligation to preserve Village
Turf’s financial records. Tr. at 140. Given these facts, the Government has presented a good
case for spoliation, but the Court does not have to reach that question because Kobus has not
established the proper amount by a preponderance of the evidence.
D.
The IRS’s Redemption of Kobus’s Home
The final question at issue in this case is whether the IRS improperly preferred itself to
Kobus’s other creditors when it purchased and resold Kobus’s house after Southern States
foreclosed on it. The IRS applied the profit it earned by reselling the house to Kobus’s tax
balance. Kobus contends that Fairfax County had a lien on his home that was senior to the tax
27
The SSA did not receive Lagasse’s W-2s for 2001, 2002, and 2003, and Lagasse had to write
letters to the SSA to get the records corrected. Exs. 150, 152; Tr. at 455-56.
28
Village Turf’s wages for 2001 were $462,243. Stip. ¶246; Ex. 31. The IRS’s wage estimate
for 2003 was $481,352.23. Stip. ¶¶283-84.
25
lien, and therefore, the IRS should have paid the funds to Fairfax County. Kobus asks the Court
to order the Government to pay the funds to Fairfax County. The relevant facts are as follows.
Between 2001 and 2007, several of Kobus’s creditors acquired interests in Kobus’s
home. In early 2001, when Village Turf entered into the dealership agreement with Southern
States, Kobus gave Southern States a deed of trust on his house. Later that year, Village Turf
became involved with a zoning dispute with Fairfax County and the County assessed Kobus with
over $100,000 in fines for various violations. In December 2001 and January 2005, the County
entered money judgments against Village Turf and Kobus. Exs. 142, 144. Although the record
in this case contains the County’s judgments, there is no evidence showing that the County filed
those judgments as liens against Kobus’s personal home. Two years later, in January 2007, the
IRS placed a tax lien on Kobus’s home as part of its effort to collect on the assessed penalties.
The parties agree that Southern States, through the deed of trust, held a perfected lien on Kobus’s
home and that Southern States’s lien was senior to the IRS’s tax lien and to any lien held by the
County.
After the retail store went out of business, Village Turf still had an unpaid inventory
balance with Southern States. On April 3, 2008, Southern States foreclosed on Kobus’s house.
The house was sold at auction to a person who is not a party to this case and Southern States
received the proceeds. Soon after the house was sold, the IRS elected to exercise its statutory
right to “redeem” the house by purchasing it from the winner of the auction for the purchase
price. Stip. ¶296; see 26 U.S.C. § 7425(d). The IRS then resold the property for a profit, and it
applied the proceeds to Kobus’s unpaid penalty balance. Stip. ¶¶296-97.
Under federal law, if the IRS holds a valid tax lien on a property, it acquires a right to
redeem the property whenever a senior creditor forecloses on the property and thereby
discharges the tax lien. § 7425(d); Treas. Reg. § 301.7425-4(a) (2010). The IRS can redeem the
property after the senior lien-holder sells the property at a public auction by purchasing it from
the buyer for the purchase price paid plus interest and costs. The IRS then may try to resell the
property at higher price and apply any profit to the taxpayer’s liability. Southwest Prods. Co. v.
United States, 882 F.2d 113, 117-18 (4th Cir. 1989). The provision allows the IRS to capture the
difference between the auction price, which is usually a distress price, and the property’s fair
market value. Id. at 118. The IRS’s right of redemption is separate from any rights it has as a
junior lien holder.
Kobus does not dispute that the IRS had a right to redeem the property. Instead, he
asserts that the IRS should have paid to Fairfax County the profits it received from redeeming
and reselling Plaintiff’s house. Kobus contends that, because Fairfax County had a senior lien on
the property, it was a senior creditor to the United States. Therefore, Kobus argues, Fairfax
County was entitled to be paid the funds the IRS received from the resale.
The Government advances two arguments asserting that Kobus has not alleged a basis for
recovery. 29 It first argues that Fairfax County never had an enforceable interest in the house
29
The Government also argues in passing that Kobus does not have standing to challenge the
sale. The parties have not pursued or fully briefed the standing issue. The Court therefore will assume
26
because the County failed to perfect its interest in the property by filing a judgment lien. The
Court agrees with the Government. Kobus has not presented a copy of any judgment lien from
Fairfax County’s land records and he has not presented any other evidence showing that Fairfax
County had a perfected judgment lien on his property. Therefore, he has not established that
Fairfax County had an interest in his property that was superior to the IRS’s tax lien. See VA.
CODE ANN. § 8.01-458 (a judgment does not become a lien on real property until the “judgment
is recorded on the judgment lien docket of the clerk’s office of the county or city where such
land is situated . . . .”); In re Charco, Inc., 432 F.3d 300, 306 (4th Cir. 2005) (to have priority
over a federal tax lien, judgment must be perfected against debtor’s property pursuant to state
law).
Second, the Government argues that, even if the County had a valid lien, the lien was
extinguished when Southern States foreclosed on the property. Again, the Court agrees with the
Government. Under Virginia law, junior liens are discharged when a senior lien-holder sells the
property. Schmidt and Wilson, Inc. v. Carneal, 180 S.E. 325, 326-27 (Va. 1935); Southwest
Prods., 882 F.2d at 115 n.1 (stating that if a senior creditor forecloses on a property, “under
Virginia law junior liens . . . are discharged at the time of sale”). During closing arguments,
Kobus agreed that a foreclosure sale by a senior lien holder cut off the rights of junior lien
holders. Closing Arg. Tr. at 38-40.
Thus, when Southern States sold the property, all junior interests were extinguished,
including the IRS’s lien and any lien held by Fairfax County. Even if the County’s lien was
senior to the IRS’s lien on the property, that relationship was extinguished when Southern States
foreclosed. Because Southern States’s foreclosure completely extinguished the interests of all
junior creditors, the IRS was under no obligation to pay any of the redemption proceeds to
Fairfax County. So even assuming Fairfax County had a perfected interest in the property, that
interest was cutoff and the IRS properly applied the redemption proceeds to Kobus’s tax balance.
Accordingly, the Court finds that Kobus has not established that the Government must remit the
proceeds of the sale to Fairfax County.
III.
Conclusion
For the reasons set forth above, Plaintiff’s request for a refund is DENIED and the
Government’s counterclaims are GRANTED. The Government represented that collection
efforts have been ongoing. Therefore, the Government is ordered to obtain updated account and
balance information. The parties are ordered to confer and if possible stipulate as to the correct
outstanding balances on Plaintiff’s accounts. The parties shall file a joint status report by
Thursday, March 29, 2012.
s/ Edward J. Damich
EDWARD J. DAMICH
Judge
that Kobus has standing because, whether the Court considers this issue based on standing or on the
merits, the result is the same: Kobus is not entitled to any recovery.
27
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