What Is a Trust Fund Recovery Penalty (TFRP): Your Ultimate Guide

If your company has been struggling with tax issues and the resulting penalties, the trust fund penalty (TFRP) can be a crushing blow with far-reaching consequences for your personal financial security and future.

But all is not lost...

Join us as we discuss common questions, such as "what is the trust fund recovery penalty?" and, "how do you avoid the trust fund recovery penalty?"

So, what is a trust fund recovery penalty?

Also sometimes referred to as the “responsible person penalty,” a trust fund recovery penalty is a personal liability that may occur if a company’s payroll taxes are not properly remitted to the Federal government.

Typical examples of employment taxes not remitted are Medicare and social security deductions from employees' wages.

It forms part of the payroll tax audit, and is definitely not something you should ignore.

How much is the trust fund recovery penalty?

For uncollected tax, the trust fund recovery penalty calculation is the employee's part of any withheld FICA taxes plus withheld income taxes, and will be the same amount as unpaid trust fund taxes. For collected taxes, trust fund recovery penalties are the unpaid amount of collected excise taxes.

When and how do trust fund recovery penalties occur?

When a company does not pay over the trust fund taxes in a timely manner, the IRS may assess this penalty against any “responsible person” in the company.

According to IRS form 6672 of the Internal Revenue Code:

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

Trust fund taxes are viewed differently from other taxes, and suspected cases of trust fund tax fraud are investigated separately.

Your employees will receive credit for the withheld taxes, even if you fail to pay them over to the IRS, but you may be considered personally responsible and liable for both the owed taxes and the penalty. 

What does the IRS consider for the "intent to defraud" factor?

As the Internal Revenue states, the penalty applies to anyone who willfully fails to pay over the trust fund taxes. To qualify as willful evasion, you generally must

• Know that the taxes are due for remittance
• Make a decision to not pay the taxes, either intentionally disregarding the law or being plainly indifferent to the requirements of the law. It’s important to note that no evil intent or bad motive is required.

One of the most common trust fund tax issues for small businesses often arises when you are dealing with cash flow issues.

Usually, your FTDs are due every two weeks, or even semi weekly, depending on how much tax is owed.

If money is very tight, some small business owners may make the decision to use the withheld trust funds to pay suppliers. This happens because suppliers may cease deliveries or services when invoices are due, and the IRS may be slower to ask for their money.

This is a serious mistake. Treating the IRS like a regular creditor or, worse, as a short-term loan is extremely risky, and potentially very costly.

Not only do they charge interest but also steep late fee penalties of up to 20% and further interest on those penalties.

If they determine that you have been willfully failing to pay over these trust fund taxes, you also open yourself up to personal liability for the trust fund penalty.

The IRS considers using trust funds to pay other creditors willful evasion. According to the IRS website:

"Willfully" in this case means voluntarily, consciously, and intentionally. You are acting willfully if you pay other expenses of the business instead of the withholding taxes.

Don't forget: the trust fund recovery penalty statute of limitations applies

Generally speaking, the trust fund recovery penalty statue of limitations in the Withholding or Federal Insurance Contribution Act (FICA) is 3 years from the date the related return is filed or when the return is due—whichever is the later.

Check out our California tax audit statute of limitations guide for more information.

Who is liable for the trust fund recovery penalty?

One of the most important things to note about the TFRP is that it may be levied on any responsible person in the business.

The responsible person or group of people determined by a revenue officer can be:

• Officer or an employee of a corporation,
• Member or employee of a partnership,
• Corporate director or shareholder,
• Member of a board of trustees of a non-profit organization,
• Another person with authority and control over funds to direct their disbursement,
• Another corporation or third party payer,
• Payroll Service Providers (PSP) or responsible parties within a PSP
• Professional Employer Organizations (PEO) or responsible parties within a PEO, or
• Responsible parties within the common law employer (client of PSP/PEO).

One of the most important things to note about the TFRP is that it may be levied on any responsible person in the business.

To qualify as a responsible person, according to the IRS, you must have the:

• Duty to perform the collection, accounting, and payment of trust fund taxes
• Power to direct these actions.

The second point is important: an employee who “just pays the bills” under the direction of someone else is not a legally responsible person in this context.

At the point that the IRS decides that trust fund taxes may not have been paid over properly, they may launch a trust fund recovery penalty investigation. 

The process generally begins with a letter sent to whomever the IRS considers the responsible party, requesting an interview.

If you have received such a letter, you may wish to consult a tax attorney before agreeing to an IRS interview.

Ask yourself these questions:

• Did you determine the financial policy for the business?
• Did you direct or authorize payment of bills?
• Did you open or close bank accounts for the business?
• Did you guarantee or co-sign loans?
• Did you sign or countersign checks?
• Did you authorize or sign payroll checks?
• Did you authorize or make federal tax deposits?
• Did you prepare, review, sign, or transmit payroll tax returns?

The answers to these questions, which seem simple on the surface, may be more complex in reality.

Representation by qualified counsel can help you prepare properly, so that you do not inadvertently give an answer which could get you in trouble without any explanatory clarification.

Even if you've been flagged as a responsible party for the TFRP, abatement can remove you as liable.

Trust fund recovery penalty abatement

Trust fund recovery penalty abatement is when a responsible party is being assessed for the trust fund recovery penalty but is then found to not be a responsible party. In addition, abatement can also apply if that party did not willfully fail to pay the owed tax.

What happens if you’re found responsible for a TFRP?

If you have undergone the investigation process and the IRS has determined that you are the responsible person, they will send you an official letter informing you of their plans to assess the trust fund repayment penalty against you.

The amount of the penalty is equal to the amount of unpaid tax: the unremitted income tax and the withheld FICA taxes. You are personally responsible for paying it back, no matter what the trust funds may have originally been used for. 

At this point, you will have 60 days (or 75, if the letter was mailed to you outside of the US) from the date of the letter to appeal the decision.

If you decide that you want to fight the TFRP assessment, you will need to prepare a case. The IRS has a PDF available which clearly states their appeals process, but in short, you will need to:

1. File a written protest within the time limit given.
2. Request an appeals conference. This may take place through correspondence, over the phone, or in person.
3. If you do not resolve your appeal to your satisfaction in your appeals conference, you may proceed to lodge an appeal to the courts.

If you do decide to appeal the TFRP, you may want to consider representation. Having a trusted, informed, and experienced criminal tax lawyer by your side as you work your way through the Federal tax system can be invaluable.

What if I do not pay the IRS trust fund penalty? What if I am unable pay?

Non-payment of TFRP can lead to a string of severe consequences, including the issuance of a federal tax lien, levies on your income, and even asset seizure. In severe cases, you may end up charged with tax fraud in a criminal case.

If you can not pay the IRS trust fund penalty, you have some options, though the most extreme response, bankruptcy, won’t help you: a TFRP liability is not dischargeable in bankruptcy.

If you can prove financial hardship, you may be able to qualify for an instalment plan or an offer in compromise.

1. Trust fund recovery penalty offer in compromise

A trust fund recovery penalty offer in compromise is when the business offers to settle the trust fund recovery penalty as opposed to any of the responsible parties. In essence, the business just settles the penalty amount and removes the liability from the individual.

2. Consider a trust fund recovery penalty instalment agreement

You can apply for a trust fund recovery penalty instalment agreement if you are unable to pay the penalty. If approved, the penalty is usually paid monthly until cleared. In addition, you could also qualify for "currently not collectible" (CNC) status if you can't afford to pay anything.

If you qualify for CNC, the IRS will assess the situation every 2 years.

How do you avoid the trust fund recovery penalty?

If you want to avoid the trust fund recovery penalty, you need to ensure that you are following all tax requirements. A quarterly review of the state of your payroll taxes can help you catch mistakes and oversights before they grow into a serious problem.

The other thing you can do is to make sure that you have internal controls in place, especially if you delegate part or all of your payroll operations to another person or company.

Key takeaways on the IRS trust fund recovery penalty

While the TFRP applies to a business in terms of payroll taxes, remember that the IRS deems individuals as the persons responsible.

To counter this, the business entity can step in with an offer in compromise. In addition, an assessed individual can benefit from an abatement (and no longer be liable) or an installation agreement if they're unable to pay.

If you ever have any concerns about whether you are in compliance with all tax regulations and requirements, a consultation with a qualified tax attorney may help to set your mind at ease. Your business – and your personal financial security – are on the line.

Trust fund recovery penalties: FAQs

What are the two factors the IRS considers for the trust fund recovery penalty?

The two factors the IRS considers for the trust fund recovery penalty are the total of the employees' withheld FICA taxes and the unpaid income taxes withheld. These combine to make the total unpaid withheld income taxes. If taxes are collected, the penalty is the unpaid collected excise taxes.

What is the difference between the trust fund recovery penalty and the negligence penalty?

The main difference between the trust find recovery penalty and the negligence penalty is that the negligence penalty is 20% of the owed tax. In comparison, the trust fund recovery penalty is simply the amount of the withheld employee FICA taxes and the unpaid income taxes.

What is the penalty for not paying the trust fund recovery penalty?

The penalty for not paying the trust fund recovery penalty is tax fraud in the most extreme criminal cases. Less-severe, but penalties you still want to avoid are asset seizure, federal tax lien and levies on your income. These are all easily avoided by ensuring the tax liabilities are paid.

How far back can the IRS audit a trust?

The IRS can go back 3 years to audit a trust. But note that it depends on the later of the due date or when the return was due. So, if you file a return later, the IRS has 3 years from that filing date to carry out the audit.

Even so, the IRS can go back 6 years if there is a “substantial understatement of income.” This substantiveness is if greater than 25% is not declared.

What happens if you don't file a trust tax return?

If you don't file a trust tax return, the IRS "failure to file" penalty kicks in. The failure to file penalty is 5% of the unpaid payroll taxes and remains applicable for every month (or part of a month) that the return isn't filed, up to 25% of your unpaid taxes.