Are you personally responsible for your corporation’s unpaid payroll taxes?
We have discussed payroll taxes on the blog before, covering the basics, but today we are delving a little deeper into a specific area of payroll tax compliance and consequences: the trust fund recovery penalty, or TFRP. Also sometimes referred to as the “responsible person penalty,” this refers to a personal liability which may occur if a company’s payroll taxes are not properly remitted to the Federal government. If your company has been struggling with tax issues and the resulting penalties, the trust fund penalty can be a crushing blow with far-reaching consequences for your personal financial security and future.
Introduction: What are trust fund taxes?
Federal payroll or employment tax consists of three parts:
- The Federal income tax you are required to withhold from your employees’ paychecks
- The Federal Social Security and Medicare taxes that you are required to withhold from your employees’ paychecks
- The matching employer’s part of Federal Social Security and Medicare taxes that you are required to contribute
Trust fund taxes consist of the first two components. You withhold them from your employees’ wages and hold them “in trust” until the appropriate remittance period, so these withheld funds are called trust fund taxes. As an employer, it is your responsibility to withhold these taxes and pay them over to the IRS via Federal Tax Deposits (FTDs) as required.
When and how does the trust fund recovery penalty 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 Section 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.
Why intent matters
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 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.
Who is responsible?
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 can be:
- An officer or an employee of a corporation,
- A member or employee of a partnership,
- A corporate director or shareholder,
- A member of a board of trustees of a nonprofit 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).
To qualify as a responsible person, according the IRS you must have:
- The duty to perform the collection, accounting, and payment of trust fund taxes
- The 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 an 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.
- 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.
What happens if you’re found responsible
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 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:
- File a written protest within the time limit given.
- Request an appeals conference. This may take place through correspondence, over the phone, or in person.
- 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 advocate by your side as you work your way through the Federal tax system can be invaluable.
What if I do not pay? 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 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 installment plan or an offer in compromise.
How to steer clear of the trust fund recovery penalty
If you want to stay out of the crosshairs of the IRS and prevent serious tax issues such as the TFRP, 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.
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.