Legacy Law Blog

When you run a business and have employees, you take on a critical responsibility: withholding payroll taxes from your employees’ paychecks and remitting those funds to the IRS.

These “trust fund taxes,” which include federal income tax, Social Security and Medicare, are not your company’s money. They are held in trust for the government. Failing to pay them to the IRS as prescribed by law can trigger one of the harshest penalties in the tax code: the Trust Fund Recovery Penalty (TFRP).

This post will review what the TFRP is, who can be held liable, how the IRS investigates and assesses this penalty, and what steps you can take to avoid or resolve it.

What Are Trust Fund Taxes?

Trust fund taxes are the amounts withheld from employees’ wages for federal income tax, Social Security, and Medicare (FICA). Employers are required to collect these taxes and hold them in trust until they are deposited with the IRS from all W-2 employees. The IRS considers these funds to be government property from the moment they are withheld from the employee’s income.

What Is the Trust Fund Recovery Penalty (TFRP)?

The TFRP is a penalty assessed by the IRS when an employer willfully fails to collect, account for or pay over trust fund taxes. The penalty is severe; it is equal to 100% of the unpaid trust fund taxes, not including the employer’s share of FICA, but including all withheld income, Social Security and Medicare taxes from employees’ paychecks. The IRS also charges interest on the unpaid amount.

For example, if a business withholds $10,000 in payroll taxes but fails to remit them, the IRS can assess a $10,000 TFRP against the business and personally against each individual responsible for the collection and payment of payroll taxes to the federal government. In other words, if the business is found to have willfully failed to collect, account for or pay trust fund taxes totaling $10,000, it and all employees responsible for these collected taxes are liable to the IRS for $20,000 plus interest for the unpaid payroll taxes.

Who can be Held Liable?

The reach of the TFRP is broad. The IRS can hold any “responsible person” personally liable for the unpaid taxes. This includes:

• Owners, partners and corporate officers
• Employees with authority over financial decisions
• Payroll managers, bookkeepers and accountants
• Board members, trustees and even outside payroll providers with payment authority

Responsibility is based on who had the power to ensure the taxes were paid, not just job titles. If you had the authority to pay creditors and were aware of the unpaid taxes, you can be held liable even if you don’t own the company.

What Is “Willfulness?”

To assess the TFRP, the IRS must show that the responsible person’s failure to pay was “willful.” Willfulness means that the person knew (or should have known) about the unpaid taxes and either intentionally disregarded the law or was plainly indifferent to its requirements. Using withheld taxes to pay other bills or creditors instead of the IRS is a classic example of willful behavior.

How the IRS Investigates and Assesses TFRPs

The IRS begins by identifying who was responsible for collecting and paying payroll taxes. This process often involves reviewing:

• Bank statements and cancelled checks
• Signature cards and corporate documents
• Meeting minutes and payroll records

If the IRS believes you are responsible, it will send a letter proposing to assess the penalty. You have 60 days (75 if outside the U.S.) to appeal. If you don’t respond or your appeal is unsuccessful, the IRS will assess the penalty and issue a Notice and Demand for Payment. At this point, the IRS can pursue your personal assets, including filing liens or levies against the bank accounts of the business or responsible persons.

Statute of Limitations

The IRS has three years from the date the payroll tax return was due to assess a TFRP, and 10 years from the assessment date to collect it. If you never file a return, the clock doesn’t start, and the IRS can assess at any time. This is why it is never a good idea to not file tax returns for the business regardless of how much time has passed from the date that the returns were originally due to be filed.

Multiple Responsible Parties

The IRS can, and often does, assess the full penalty against multiple individuals. Each responsible person is jointly and severally liable, meaning the IRS can collect the entire amount from any one of them. If you pay more than your share, you may seek contribution from other responsible parties, but this is a separate legal action. This is very important. The IRS will not care from whom it collects the TFRP.

How to Avoid a TFRP

• Always deposit payroll taxes on time. Set reminders and use electronic payment systems to avoid missed deadlines.
• Monitor delegated payroll duties. Even if you use a payroll service, verify that taxes are being paid.
• Stay informed. If you have financial authority, make sure you know the status of payroll tax deposits.
• Don’t prioritize other business or personal bills over payroll taxes. This is one of the most common reasons that payroll taxes are not deposited with the federal government as required by law.

What If You’re Assessed a TFRP?

If you receive notice that the IRS intends to assess a TFRP:

• Act quickly. Respond within the appeal window to contest the penalty if you believe you are not responsible.
• Seek professional help. Tax professionals can help you navigate the investigation, appeal or negotiate payment options.
• Consider payment plans or settlement. The IRS may allow installment agreements or, in rare cases, an Offer in Compromise to settle the debt for less than the full amount.

Conclusion

The TFRP is one of the most aggressive and far-reaching enforcement tools the IRS has. It can pierce the corporate veil and hold individuals personally liable for unpaid payroll taxes, with penalties equal to the entire trust fund tax shortfall.

If you have any authority over payroll decisions, vigilance is essential. If you are facing a TFRP investigation or assessment, seek professional advice immediately to protect yourself and your assets.

Understanding your responsibilities and acting promptly can help you avoid the severe consequences of the TFRP and keep your business-and personal finances-out of IRS trouble.