Businesses are responsible for paying their employees. It goes without saying that a person should be paid for the work they do, and any sort of wage theft or stolen labor is wrong. But businesses are also responsible for withholding a portion of every employee’s wage for tax purposes or risk incurring a trust fund recovery penalty. In addition to tax withholding, employers must also withhold wages for Federal Insurance Contributions Act (FICA) taxes – equal to a total of 7.65 percent of each paycheck – and match that with their own revenue.
Until that money goes to the IRS, anyone employing and paying other people must hold that money in trust and ensure that it finds its way to the government. But what if you need the money to survive a dry patch? What if you use it for something other than taxes, such as financing for major equipment purchases or to get out of another debt? That’s what a trust fund recovery penalty is for.
What Is the Trust Fund Recovery Penalty?
Employers and businesses have a responsibility to withhold employee income taxes and payroll taxes, as well as pay their own employer payroll tax for each employee. That’s money held in trust for the IRS, and every business has a fiduciary duty to ensure their taxes and their employees’ taxes are paid. It’s important to stay up to date on employer tax guides to ensure no penalties are incurred.
Failing to do so by the time these taxes are due can result in a trust fund recovery penalty. The IRS issues this penalty to individuals, not to businesses. Why does this matter? Because even though the veil of partnerships and companies with limited liability, the responsible individual can be found liable for a trust fund recovery penalty if they fail to withhold the proper amount for their employees’ taxes and their own.
When issuing a trust fund recovery penalty, the IRS launches an investigation into the offending company to figure out who should be responsible for the penalty. The value of the penalty is equal to the taxes owed. The trust fund penalty is an alternate means of collection for the trust portion of business taxes due. The IRS can collect any amount from either the business or any liable individual, up to the total owed.
They cannot collect the tax due more than once, though they are able to recover penalties and interest from the business. An important distinguishing qualification for a trust fund recovery penalty is that the IRS must establish that the choice not to deposit the tax withholdings is willful but is not required to be malicious. It doesn’t matter whether you were intentionally trying to cheat the government out of employee taxes, as long as the money was used for something other than paying taxes.
Motive doesn’t matter. Even if it was for a good reason – such as paying another creditor to avoid defaulting on an important loan or lease – if it can be established that the money was withheld for a federal tax deposit and then not deposited (or used elsewhere), you may be liable for the trust fund recovery penalty.
What Do Trust Funds Have to Do With It?
Trust funds and trust accounts have nothing to do with the TFRP. It is called such because, functionally speaking, the IRS considers all money withheld from wages and revenue for tax purposes as “held in trust” until a federal tax deposit is made. You don’t have to put your tax deposits into a trust account between payments to the government to be held liable for a TFRP, you are considered to be the trust account, as you are the party holding the funds in trust.
Who Can Be Held Liable?
When investigating a business for a trust fund recovery penalty, the IRS will look for the individual primarily responsible for the management of payroll taxes and withheld wages – not necessarily the person responsible for the business. You could be a minority shareholder, or not even a shareholder, in an S corporation with the power to write paychecks/manage the books, and if your decisions led to the inability to make a federal tax deposit, you would still be held liable for 100 percent of the ensuing tax debt and penalty. A few examples of individuals the IRS might look at during its investigation include:
- An officer of the corporation or partnership,
- A shareholder or corporate director,
- A CEO,
- Anyone with control over the funds,
- A third-party payer,
- Payroll managers or payroll service providers,
- And so on.
Responsibility is the key here. The IRS will not necessarily punish the person responsible for writing the checks if it turns out that the order came from higher up. Someone who would otherwise be risking their job if they refused to carry out an order like this shouldn’t be held liable for the ensuing tax debt. However, this is a challenging assertion to prove and may require the assistance of a tax professional.
The Trust Fund Recovery Penalty Investigation Process
Determining responsibility and figuring out who to hold liable for the TFRP is determined during the investigation, primarily through individual interviews. These interviews are conducted either in person or via phone. In addition, an investigating IRS officer will either send to you or fill out for you Form 4180 over the course of the interview. The form is usually filled out while in contact with the officer, not alone. The interview is all-important for the investigative process, and it is all-important to you as a manager or officer of the business.
It is your chance to stand by your innocence and prove a lack of responsibility and/or willfulness in the entire fiasco. You do not have to be interviewed alone. You do, in fact, get the chance to seek a personal representative to be with you during an in-person interview with an IRS employee. If the IRS has begun investigating your business for withholding federal tax deposits, it may very well be in your best interest to seek the services of a tax representative. The more complicated the business structure, the more difficult the investigation.
It can take some time for the IRS to determine who they consider being the most responsible party. Of course, in a business with just three managing figures, the answer is usually a little easier to determine. But when it’s a regional or multiregional business with multiple departments and offices, then it’s likely that the TFRP is both much more substantial and that establishing responsibility is much trickier.
Trust Fund Recovery Penalty Appeals
If you’ve “failed” your interview (i.e., the IRS is saddling you with the tax debt), all is not lost. If you aren’t responsible for the event, you can make an appeal to the IRS before the debt and penalty are applied to you. You typically have a 60-day limit beginning from the date of the notice of your impending penalty. Again, it would be wise to seek out an experienced tax law firm or a tax attorney in this situation.
When Is Litigation an Option?
If your appeal fails, you must pay the trust fund recovery penalty, except to the extent the taxes get paid by the business, but you can seek a refund for them. The IRS won’t agree to a refund, which will land you in court against them. At this point, the courtroom is your best bet to reassert your innocence and your last hope at avoiding the fate of the scapegoat. It is highly advisable to seek thorough legal counsel well before this takes place.
Paying the Debt
If you are the responsible party, then paying the debt as soon as possible is certainly in your best interest. Penalties and interest rates for unpaid taxes are steep, and tax debt can grow significantly before it is completely paid off. However, you can minimize and even eliminate certain penalties and interest if this was your first offense and if you show commitment to a payment plan with the IRS through consecutive payments and an automated payment agreement (i.e., Direct Debit Installment Agreement). If you need help resolving your tax debt, consider getting in touch with an experienced tax professional.