Trust Fund Recovery Penalty
If your business owes payroll or employment taxes, the IRS has the option to make responsible persons in the business personally liable for a portion of the back payroll taxes. This is called the Trust Fund Recovery Penalty.
To encourage prompt payment of payroll 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 employees’ money in trust until you make a federal tax deposit in that amount. The Trust Fund Recovery Penalty may be assessed if the business fails to pay all employment taxes owed. The Trust Fund Recovery Penalty can be assessed to both operating businesses and closed businesses.
Trust Fund Portion Calculation
Payroll or employment taxes are composed of three parts.
1) Federal Withholding – Taxes withheld from the employees’ wages by the employer and paid to the IRS by the employer.
2) Employee FICA – Social Security and Medicare taxes withheld from the employees’ wages by the employer and paid to the IRS by the employer. The FICA amount is 7.65% of each employee’s wages.
3) Employer FICA – Social Security and Medicare taxes paid by the employer. The employer will pay 7.65% of the employees’ wages.
The Trust Fund Portion includes Federal Withholding and Employee FICA, but not Employer FICA.
If the business fails to pay Trust Fund Portion, the IRS may assess persons responsible a Trust Fund Recovery Penalty. The Trust Fund Recovery Penalty equals the Trust Fund Portion of business payroll taxes.
Who is a Responsible Person?
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 have 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) or responsible parties within a PSP
- Professional Employer Organizations (PEO) or responsible parties within a PEO
- Responsible parties within the common law employer (client of PSP/PEO)
For willfulness to exist, the responsible person:
- Must have been aware, 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.
Trust Fund Recovery Investigation
The IRS will conduct an investigation. This is done to determine all responsible persons for paying the payroll taxes. The IRS may interview you 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.
Trust Fund Recovery Penalty Assessment
If the IRS determines that you are a responsible person, the IRS will mail you a letter about the Trust Fund Recovery Penalty assessment. The letter will explain your appeal rights. You will have 60 days (75 days if this letter is addressed to you outside the United States) from the date of the letter to appeal the IRS assessment. If you do not respond to the letter, the IRS will assess the penalty against you and send you a Notice and Demand for Payment.
Paying Trust Fund Recovery Penalty
When you owe the Trust Fund Recovery Penalty, the IRS will attempt to collect from you personally and the business at the same time. The IRS can take collection action against your personal assets. For instance, the IRS can file a federal tax lien, tax levy, or take seizure actions.
This does not mean you owe double the taxes. The Trust Fund Recovery Penalty is equal to the Trust Fund Portion owed by the business. If the business pays the Trust Fund Portion, you will get credit towards the Trust Fund Recovery Penalty owed by you. If you pay the Trust Fund Recovery Penalty, the business will get credit towards the Trust Fund Portion owed by the business.
Avoiding the Trust Fund Recovery Penalty
If you owe back payroll taxes and you have some money to pay the payroll taxes, but you are not able to pay all the taxes owed, you have the option to pay the Trust Fund Portion of the payroll taxes. If the business pays the Trust Fund Portion first, then the IRS will not come after you personally for the Trust Fund Recovery Penalty.
To pay the Trust Fund Recovery Portion write a check. On the check, write the following on the memo line:
- Business EIN
- Form 941
- Tax Period
- The words “Trust Fund Portion”
Submit a separate check for each tax period owed.
You can avoid the Trust Fund Recovery Penalty by making sure that all employees’ taxes are collected, accounted for, and paid to the IRS when required. Make sure your tax deposits and payments are on time.
Additional information on employment taxes can be found in IRS Publication 15, Employer’s Tax Guide.
To better understand your appeal rights and how to prepare a protest if you don’t agree with the IRS, read IRS Publication 5.