Plаintiff-Appellant Fran Coip. (“Fran” or “Taxpayer”) appeals from a March 2, 1998 judgment entered in the United States District Court for the Southern District of New York (Charles L. Brieant, District Judge), granting the United States’ motion for summary judgment and denying plaintiffs cross-motion for summary judgment in its action seeking a refund of tax penalties. Plaintiff argued below, and now urges on appeal, that it had “reasonable cause” for its late payment and deposit of employment taxеs under 26 U.S.C. §§ 6651(a)(2) and 6656(a), respectively, and thus should not have been assessed penalties under those provisions. The district court found that Fran’s failure to pay and deposit its employment taxes was due not to “reasonable cause,” but to “willful neglect.” For the following reasons, we affirm the judgment of the district court.
BACKGROUND
The facts are undisputed. Plaintiff-Appellant Fran has been an electrical contractor for commercial new construction and renovation projects since 1988. In 1992, Fran was completing work under two contracts, with the State of New York and with St. Thomas Aquinas College, for large projects. In that year, the State withheld progress and cost overrun payments to Fran ultimately totaling $454,854.93. Despite its refusal to pay, the State insisted that Fran complete its work or risk losing the full contract through breach. Within a year, St. Thomas Aquinas College defaulted on its payments to Frаn totaling $157,314.15.
To pay for its continuing work for the State, Fran exhausted its credit facilities and developed a plan to pay its workers fully and certain creditors partially to ensure completion of the two delinquent projects and preservation of the business as a going concern. Fran made partial payments to its employees’ union during this period as well. The Government conceded for the purposes of its summary judgment motion below that Fran did not have sufficient cash flow or assets to pay all of its employees, creditors, and taxes. There is no dispute that Fran faced severe financial difficulties during this period.
As a result of such difficulties, during the five quarters between April 1993, and June 1994, Fran failed to pay approximately one half of its employment taxes, which totaled $286,426.98. These included federal income taxes, social security taxes (FICA), and Medicarе taxes which it was required to pay for its workforce. 1 Fran also filed its quarterly tax returns late for the second and fourth quarters of 1993 and the second quarter of 1994. During these five quarters, Fran had revenues of $7,394,256.
On July 17,1994, New York State officially acknowledged its duty to pay-Fran’s entire claim of $454,458 for payments due under its contract with Fran and, based on that representation, Fran managed to obtain a $200,000 bank loan to pay its taxes. By October 1995, Fran had paid the entire balance of taxes owed, interest, and penalties for (1) failure to file returns ($6,327.63), imposed pursuant to 26 U.S.C. § 6651(a)(1); (2) failure to pay taxes ($12,768.77), imposed pursuant to 26 U.S.C. § 6651(a)(2); and (3) failure to deposit taxes ($52,654.32), imposed pursuant to 26 U.S.C. § 6656(a).
On January 7,1997, Fran filed a complaint in the Southern District of New York to recover the $71,750.72 in penalties paid to the Internal Revenue Service (“IRS”). On November 17, 1997, the Government moved for summary judgment. On January 16, 1998, Taxpayer cross-moved for summary judgment. The District Court granted the Government’s motion and denied that of Taxpayer in an opinion dated February 27,1998, and judgment was entered for the Government on March 2,1998.
DISCUSSION
We review de novo a district court’s decision to grant summary judgment, and use the standard applied by the district court.
See Gerald B. Lefcourt, P.C. v. United
1. Reasonable Cause
The IRS imposes mandatory penalties for failure to file returns, pay taxes, or deposit employment taxes in a government depository unless the taxpayer can demonstrate that such failure was due to “reasonable cause and not due to willful neglect.” 26 U.S.C. §§ 6651(a)(1), (a)(2), 6656(a). Addressing the application of Section 6651(a)(1), the Supreme Court established that the taxpayer bears the “heavy burden of proving both (1) that the failure did not result from ‘wilful neglect,’ and (2) that the failure was ‘due to reasonable cause.’ ”
United States v. Boyle,
In
Boyle,
the Court interpreted the phrase “willful neglect” in Section 6651 (a)(1) to mean “a conscious, intentional failure or reckless indifference.”
2
The meaning of “reasonable cause” is more controversial, at least in the context of penalties for an employer’s failure to pay taxes on behalf of its employees and, in particulаr, when the taxpayer asserts that financial difficulties should be considered reasonable cause.
3
We note first that “what elements must be present to constitute ‘reasonable cause’ is a question of law.”
Id.
at 249 n. 8,
The Treasury Regulations interpreting the “reasonable cause” provision of Section 6651 state, in pertinent part, as follows:
If the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time, then the delay is due to a reasonable cause. A failure to pay will be considered to be due to reasonable cause to the extent that the taxpayer has made a satisfactory showing that he exercised ordinary business care and prudence in providing for payment of his tax liability and was nevertheless either unable to pay the tax or would suffer an undue hardship (as described in § 1.6161-1 (b) of this chapter) if he paid on the due date.
26 C.F.R. § 301.6651-l(c)(l) (emphasis supplied). An “undue hardship” is defined as
26 C.F.R. § 1.6161 — 1(b) (emphasis supplied). To assess the evidentiary basis for a finding of reasonable cause,
consideration will be given to all the facts and circumstanсes of the taxpayer’s financial situation, including the amount and nature of the taxpayer’s expenditures in light of the income (or other amounts) he could, at the time of such expenditures, reasonably expect to receive prior to the date prescribed for the payment of the tax.
26 C.F.R. § 301.6651-l(c)(l) (emphasis supplied). In this analysis, “lavish or extravagant expenses” or investments in “speculative or illiquid assets” that render a taxpаyer’s remaining assets insufficient to satisfy its tax obligations point to a failure to exercise ordinary business care and prudence. Id.
Finally, Section 301.6651-l(e)(2) of the Regulations provides:
In determining if the taxpayer exercised ordinary business care and prudence in providing for the payment of his tax liability, consideration will be given to the nature of the tax which the taxpayer has failed to pay. Thus, for example, facts and circumstances which, because of the taxpаyer’s efforts to conserve assets in marketable form, may constitute reasonable cause for nonpayment of income taxes may not constitute reasonable cause for failure to pay over taxes described in section 7501 that are collected or withheld from any other person.
26 C.F.R. § 301.6651-l(c)(2) (emphasis supplied). Section 7501 governs the
employee
portion of taxes which are collected or withheld by an employer as salaries are disbursed. In relevant part, Section 7501 establishes that “the amount of tax so collected or withheld shall be held to be a special fund in trust for the United States.” 26 U.S.C. § 7501(a). Accordingly, the taxes an employer withholds from and pays on behalf of its employees are often called “trust fund taxes.”
Begier v. Internal Revenue Service,
The parties dispute whether financial difficulties such as those faced by Fran can ever constitute “reasonable cause” to avoid the penalties at issue. The Government argued unsuccеssfully below, and asserts again on appeal, that we should adopt the reasoning of the Sixth Circuit Court of Appeals in
Brewery, Inc. v. United States,
since the funds not deposited or paid to the IRS in this case were funds held in trust for the United States under 26 U.S.C. § 7501, the facts and circumstances required to establish reasonable cаuse must be particularly compelling.
Id. Given this heightened standard, the Sixth Circuit held that “the use of trust funds for the payment of other creditors cannot, as a matter of law, constitute reasonable cause.” Id. Among the Circuits, only the Sixth Circuit Court of Appeals appears to have defined the content of the reasonable cause test in the context of a failure to pay trust fund taxes. 5
We believe that the district court properly declined to embrace the bright line rule of
Brewery.
Such a rule finds no support in either the penalty provisions of the statute or in the longstanding Treasury Regulations drafted to implement those provisions. Sections 6652 and 6656 neither bar the consideration of financial difficulties in determining whether reasonable cause has been proven, nor differentiate betwеen trust fund taxes and other taxes which are not kept in trust for the benefit of the IRS. This is particularly significant with respect to Section 6656, which specifically addresses the failure to deposit employment taxes yet requires neither a higher standard in such cases nor that courts turn a blind eye to a taxpayer’s financial circumstances. The “reasonable cause”/“wilful neglect” standard has been part of the penalty provisions of thе tax statutes since 1916, and Congress has not amended these provisions to create a different standard for the failure to pay trust fund taxes.
See Boyle,
The Treasury Regulations, moreover, specifically require courts to assess “all the facts and circumstances of the taxpayer’s financial situation,” 26 C.F.R. § 301.6651-1, and to determine whether the taxpayer would have suffered “undue hardship,”
id.,
or “substantial financial loss,” 26 C.F.R. § 1.6161-(l)(b), from the payment of taxes. These pоrtions of the Treasury Regulations have remained unchanged since at least 1973, and in the case of Section 1.6161-1, since 1960. Such regulations “long continued without substantial change, applying to unamended or substantially reenacted statutes, are deemed to have received congressional approval and have the effect of law.”
Cottage Savings Ass’n v. Commissioner,
Nor does the provision upon which the Brewery Court relied, 26 C.F.R. § 301.6651-1(c)(2), support a bright line rule. That provision simply requires that we consider, among other factors in our analysis of the taxpayer’s care and prudence, “the nature of the tax which the taxpayer has failed to pay,” and provides an illustrative example to suggest that
facts and circumstances which ... may constitute reasonable cause for nonpayment of income taxes may not constitute reasonable cause for failure to pay over taxes described in section 7501 that are collected or withheld from any other person.
Id.
(emphasis added). While courts must consider the obligations to pay Section 7501 trust fund taxes in their analysis of reasonable cause, their analysis may not stop there. We recognize that it will be the rare case where the government is made the “unwilling partner in a floundering business,”
Brewery,
II. Application of the Law to Taxpayer’s Conduct
The district court found that Fran had failed to exercise “ordinary business care and prudence” and that its “failure to file and pay its taxes in a timely fashion was the result of either ‘carelessness, reckless indifference, [or] intentional failure.’ ”
Fran Corp. v. United States,
In its brief on appeal, counsel for Fran characterizes the 1991 loan to Heilman as an effort to enhance Fran’s balance sheet by listing Heilman’s annual dividend as a debt owed to Fran. This characterization contradicts the straightforward description of the loan Heilman gave in his affidavit on the motion and must be disregarded. It is undisputed that Fran continued to pay rent to Heilman during the entire period of delinquency despite its tax obligations. Fran argues that the fact that Heilman owned the office space which Fran rents is irrelevant because Fran would have had to pay rent to some entity if not to Heilman. This argument ignores the critical fact that another landlord would not have owed Fran almost $150,000. Clearly, the prudent course would have involved at least a suspension of all payments to Heilman, if not a demand for Heilman’s repayment of the loan, until Fran paid its taxes. The decision to give priority to the company’s president as creditor over the IRS demonstrates the absence of ordinary business care and prudence.
Similarly, Fran’s decision to fund numerous auto leases and repairs bеfore paying the IRS further undermines its argument. These expenses included the repair of a Porsche that even Fran declines to eharac-
Finally, the entertainment expenses cited by the district court demonstrated imprudence in setting the company’s financial priorities during the period. The expenditures totaled $11,298.25 for 1993, and $4,914.53 for 1994. Fran argues that its golf and hockey outings constituted business develоpment work. Even if true, however, there is no evidence in the record to link these outings to the two projects which Fran claims it needed to complete to avoid defaulting on its contracts. Similarly, the record reflects that Fran paid for two dinner dances during the same period which it has not linked to the critical projects in any way. While not overwhelming in size, these expenditures support the district court’s finding that they were “lavish or extrаvagant” because the preservation of the business did not require them to be made. 26 C.F.R. § 301.6651-l(e)(l).
Perhaps most important is Fran’s failure to provide any evidence to show that it placed its obligations to the IRS before those to any and all creditors not directly related to the two projects that defaulted. Absent such a showing, Fran cannot demonstrate that it acted prudently in disregarding its legal obligations to pay and deposit the emрloyment taxes. It was not clear error for the district court to find that the Taxpayer had not demonstrated that its failure to pay and deposit taxes was due to reasonable cause and not to wilful neglect.
CONCLUSION
A taxpayer may, under appropriate circumstances, demonstrate that it had reasonable cause for its failure to pay and deposit employment taxes by showing that it exercised ordinary business care and prudence in the face of financial difficulties, yet was either unable to pay the tax or would have suffered undue hardship if it had paid when required. Fran has not shown that it exercised ordinary business care and prudence in addressing its obligations to pay and deposit employment taxes. Accordingly, we affirm the judgment of the district court.
Notes
. Employers are required to withhold these taxes from employees’ salaries as they are paid and to pay over the withheld amounts to the IRS by depositing the taxes in a federal depositary at specified intervals each quarter. See 26 U.S.C. §§ 3101, 3102(a), 3102(b), 3111, 3402, 3403, 6302.
. While the analysis in Boyle addressed penalties for failure to file a return under Section 6651(a)(1) and not for a failure to pay or deposit taxes under Section 6651(a)(2) or Section 6656, the language concerning the standard is identical in all three provisions. Unless otherwise noted, therefore, we shall inform our analysis of Sections 6651(a)(2) and 6656 with those precedents that address Section 6651(a)(1).
. The IRS has identified certain circumstances, not present here, that are considered to be reasonable cause: (1) unavoidable postal delays; (2) timely filing of a return with the wrong IRS office; (3) death or serious illness of the taxpayer or a member of his immediate family; (4) the taxpayer's unavoidable absence from the United States; (5) destruction by casualty of taxрayer's records or place of business; and (6) reliance on the erroneous advice of an IRS officer or employee.
See McMahan,
.The Taxpayer conceded at oral argument that it did not have reasonable cause to avoid timely filing its returns and, therefore, does not appeal the district court's judgment as to those penalties imposed pursuant to 26 U.S.C. § 6651(a)(1) in the amount of $6,327.63.
. Numerous lower courts have adopted thе bright line rule embraced in
Brewery. See, e.g., Bostar Foods, Inc. v. United States,
No. CIV. A. 3:95CV-811-S,
Several lower courts have found "reasonable cause” based on the taxpayer’s financial difficulties.
See, e.g., In re Slater Corp.,
. Indeed, even if we believed the statutory provisions at issue to be ambiguous, we would be required to defer to the Secretary’s quite permis