Understanding the Trust Fund Recovery Penalty
To encourage employers to make timely payments of payroll withholding, employment taxes and sales taxes, IRS tax law includes a provision called the Trust Fund Recovery Penalty. These taxes are called trust fund taxes as they are actually held in trust by the employer from the employees wages. They are considered to be held in trust until they are submitted to the taxing authority by making a federal or state tax deposit for that amount.
Tax law allows the IRS to assess the TFRP/Trust Fund Recovery Penalty to late paying employers who are not immediately submitting payments to the IRS. Please note this penalty can be assessed at any time a business is late in paying their taxes and the business does not have to be still operating or be closed in order for the TFRP to be assessed.
The Trust Fund Recovery Penalty can be assessed to any person to whom:
- Is responsible for collecting and paying withheld income, employment and sales taxes.
- Willfully fails to collect or pay them (withheld income, employment and sales taxes).
A responsible person/party is an individual or group of people who have the duty to perform and direct the collecting, accounting and paying of trust fund taxes. The responsible person/party may be an:
- Officer or employee of a corporation
- A member or employee of a partnership
- A Corporate Shareholder or Director
- An individual with authority and control over funds to direct their disbursement
- Another corporation
To determine willfulness, the responsible person must have been, or should have been aware that the outstanding taxes are due and payable and have intentionally disregarded the law or have been indifferent to its requirements (no bad intent or bad motive is required). Using available funds to pay other creditors when the business is unable/unwilling to pay the employment/sales taxes when due is an indication of unwillfulness to pay the trust fund taxes when they are due.
If you do not pay your taxes when due, the IRS may require that you complete and interview in order to determine the full extent of your responsibilities and duties. A responsible party’s duty is based upon whether an individual exercises prudent judgment with regards to the financial affairs of the business. For example an employee is not a responsible person if an individual’s function is solely to pay the bills as directed by a superior, rather than one that determines which creditors will or will not be paid. IRS Notice 784 (Could You Be Personally Liable for Certain Unpaid Federal Taxes?) is a great resource for additional information.
You can determine the TFRP amount as it is equal to the unpaid balance of the trust fund tax and is equal to the unpaid income taxes withheld plus the employee’s portion of the withheld FICA taxes (Social Security & Medicare).
If the IRS determines that you are a responsible person who willfully did not pay the trust fund taxes when due they will send you a letter stating their intent to assess the TFRP against you personally. You will then have 60 days, from receipt of the letter, to appeal their proposal. You will also receive details on your appeal rights as detailed in IRS Publication 5 (Your Appeal Rights and How to Prepare a Protest if You Don’t Agree).
Once the IRS has assessed the penalty they make take collection action against your personal assets. For example, at this point the IRS can file a federal tax lien or take levy or seizure action against your personal assets.
You can avoid the Trust Fund Recovery Penalty personally by making sure that all employment taxes are collected, accounted for and paid to the IRS as legally required by making sure that all of your payroll tax reports are timely filed and paid. To read more on this you can review IRS Publication 15 (Employer’s Tax Guide) and instructions for IRS Form 941 (Employer’s Quarterly Federal Tax Return)
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