IRS PAYROLL TRUST FUND
A trust fund tax is money withheld by an employer from an employee's wages (income tax, social security, and Medicare taxes) and held in trust until paid to the Treasury. When you pay your employees, you do not pay them all the money they earned.
As their employer, you have the added responsibility of withholding taxes from their paychecks. The income tax and employees' share of FICA (social security and Medicare) that you withhold from your employees' paychecks are part of their wages you pay to the Internal Revenue Service (IRS)/Treasury instead of to your employees. Your employees trust that you pay the withholding to the IRS by making Federal Tax Deposits. That is why they are called trust fund taxes.
Through this withholding, your employees pay their contributions toward retirement benefits (social security and Medicare) and the income taxes reported on their tax returns. Your employees' trust fund taxes, along with your matching share of FICA, are paid to the IRS through the Federal Tax Deposit System. The withheld part of these taxes is your employees' money, and the matching portion is their retirement benefit.
TRUST FUND RECOVERY PENALTY
If the trust fund taxes aren't collected, not truthfully accounted for and paid, or are evaded or defeated in any way, the IRS may charge a trust fund recovery penalty. If the IRS can't collect the taxes from the employer or business, it will decide who the responsible persons are and who acted willfully. Wilfully means voluntarily, consciously, and intentionally.
The IRS believes that a responsible person acts "willfully" if this person knows that the required actions are not taking place. A taxpayer paying other business expenses instead of payroll taxes is considered willful behavior. The trust fund recovery penalty ("TFRP") allows the IRS to collect the unpaid withholding taxes from the income and assets of the owners and those responsible persons connected to the business. The IRS may hold any person responsible who has responsibility for certain aspects of the business and financial affairs of the business.
To encourage prompt payment of withheld income and employment taxes, including social security taxes, railroad retirement taxes, or collected excise taxes, Congress passed a law that provides for the trust fund recovery penalty. These taxes are called trust fund taxes because you actually hold the employee's money in trust until you make a federal tax deposit in that amount. The trust fund recovery penalty may apply to you if these unpaid trust fund taxes cannot be immediately collected from the business. The business does not have to have stopped operating in order for the penalty to be assessed.
WHO CAN BE RESPONSIBLE FOR THE TFRP
The trust fund recovery penalty may be assessed against any person who:
Is responsible for collecting or paying withheld income and employment taxes, or for paying collected excise taxes, and
Willfully fails to collect or pay them.
A responsible person is a person or group of people who has the duty to perform and the power to direct the collecting, accounting, and paying of trust fund taxes. This person may 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);
Various other parties.
For willfulness to exist, the responsible person:
Must have been, or should have been, aware of the outstanding taxes; and
Either intentionally disregarded the law or was plainly indifferent to its requirements (no evil intent or bad motive is required).
Using available funds to pay other creditors when the business is unable to pay the employment taxes is an indication of willfulness. You may be asked to complete an interview with an IRS agent in order to determine the full scope of your duties and responsibilities. Responsibility is based on whether an individual exercised independent judgment with respect to the financial affairs of the business. An employee is not a responsible person if the employee's function was solely to pay the bills as directed by a superior, rather than to determine which creditors would or would not be paid.
FIGURING THE TFRP AMOUNT
The amount of the penalty is equal to the unpaid balance of the trust fund tax. The penalty is computed based on:
The unpaid income taxes withheld, plus
The employee's portion of the withheld FICA taxes.
For collected taxes, the penalty is based on the unpaid amount of collected excise taxes.
ASSESSING THE TFRP
If the IRS determines that you are a responsible person, it will provide you a letter stating that the IRS plans to assess the TFRP against you. You have 60 days (75 days if this letter is addressed to you outside the United States) from the date of this letter to appeal the IRS proposed assessment. The letter will explain your appeal rights. If you do not respond to the IRS letter, they will assess the penalty against you and send you a Notice and Demand for Payment.
If the IRS asserts the penalty, they can take collection action against your personal assets. For instance, they can file a federal tax lien or take levy or seizure action.
Gene M. Bowman, Attorney & CPA