Employers are required to withhold Social Security, Medicare, and income taxes from wages paid to employees. The withholdings are credited to the employee’s Social Security, Medicare, and income tax accounts. If these taxes are not paid over to the IRS and the IRS is not able to secure payment from the employer or the business owner, the IRS will typically assess a trust fund recovery penalty against one or more individuals associated with the business. This penalty allows the IRS to assess and collect the business tax from one or more individuals personally. This article provides an overview of the trust fund recovery penalty.
The Trust Fund Recovery Penalty
The trust fund recovery penalty is set out in Code 6672. Section 6672 says that an individual can only be liable for the penalty if they are a “responsible person” and they acted “willfully” in not paying the taxes.
Who is a Responsible Person?
The individual must have control over the businesses to be a “responsible person.” This means that they generally have to be able to decide which creditors to pay and have paid other creditors before paying the IRS.
The IRS typically casts a wider net than this in making this determination. The IRS will usually assess the penalty against all corporate officers, anyone with signature authority over the business checking account, and just about anyone else that has the ability to pay the business’ creditors. This can even include lower level accounting personnel. It can also include others:
- 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).
Even if the person is found to be responsible, they must have acted willfully.
What is Willful Conduct?
Willfulness “requires a voluntary, conscious, and intentional act, but not necessarily a bad motive or evil intent.” A responsible person acts willfully (1) if he knows the payroll taxes are due but uses corporate funds to pay other creditors, or (2) if he recklessly disregards the risk that the taxes may not be remitted to the government. The burden is on the person who the IRS assesses the penalty against. They have to prove that their actions were not willful.
There are a number of court cases that help clarify when an individual is a responsible person and when they acted willfully. If the IRS is asking questions about a business that has not paid its employment tax liabilities, everyone who is even remotely associated with the business finances should carefully review these court cases to see if the penalty could be applied to them personally.
Amount of the Trust Fund Recovery Penalty
The trust fund recovery penalty is equal to the amount of tax that was not paid. The trust fund recovery penalty only applies to Social Security, Medicare, and income tax withholdings. This only includes the taxes withheld from employees; it does not include the additional taxes the employer owes. For example, if the employer withholds $100 in taxes from the employee and then pays $100 of its own employment taxes, the trust fund recovery penalty would only be $100 for the $100 withheld from the employee’s wages.
How the IRS Assesses the Trust Fund Penalty
The IRS has specific procedures that it follows in applying the trust fund recovery penalty. This includes performing a structured interview of the potentially responsible person, obtaining the business bank account records to see who has signature authority, and reviewing the business minutes. This work is performed by a revenue officer, i.e., an agent responsible for tax collections.
The IRS will then issue a final determination, which gives the responsible person the ability to appeal the determination to the IRS Office of Appeals by submitting a written protest within 60 days of the date of the determination letter.
Paying the Trust Fund Penalty
The IRS has a policy of only collecting the trust fund recovery penalty and underlying employment taxes once.
The IRS also has a policy of applying any payments made to the IRS to the non-trust fund portion of the tax first. The only exception to this is if the taxpayer specifically designates the payments to the trust fund portion of the tax. This is usually advisable, as a business paying the tax can help reduce or eliminate the personal liability for the trust fund recovery penalty.