What Is the Trust Fund Recovery Penalty for Payroll Taxes?
When a business withholds income tax and the employee share of Social Security and Medicare from paychecks but does not pay it to the IRS, the IRS can assess the trust fund recovery penalty personally against anyone responsible for paying it who acted willfully. The penalty equals 100% of the unpaid trust fund taxes. Owners, officers and even bookkeepers with check-signing authority can be liable, even if the business closes.
Payroll taxes are different from other business debts. Money withheld from employees' paychecks is held "in trust" for the government, so the law makes individuals personally responsible if it is not paid.
What the penalty covers
Trust fund taxes are:
- Federal income tax withheld from employees
- The employees' share of Social Security and Medicare taxes
The employer's matching share is not a trust fund tax. The trust fund recovery penalty (TFRP) equals 100% of the unpaid trust fund amount (26 U.S.C. 6672; IRS).
Who can be liable
Any responsible person who willfully failed to collect, account for or pay over the taxes.
- Responsible person: someone with the authority and duty to decide which bills get paid, often owners, officers, directors, managers, and sometimes bookkeepers or payroll service personnel with significant control (IRS).
- Willfully: the person knew the taxes were unpaid, or recklessly disregarded the risk, and used available funds to pay other creditors instead. Intent to defraud is not required.
More than one person can be held liable, but the IRS collects the total only once.
How the IRS assesses it
- A revenue officer investigates and often interviews potential responsible persons using Form 4180.
- The IRS sends a proposed assessment letter (Letter 1153).
- You generally have 60 days to file an appeal with the IRS Independent Office of Appeals.
Why it matters
- It survives closing the business and is not limited by LLC or corporate protection.
- It is generally not dischargeable in bankruptcy.
- The IRS can use liens and levies against your personal assets.
Preventing problems
- Pay payroll taxes first when cash is short; the IRS views paying vendors or yourself while payroll taxes go unpaid as willful.
- Use the Electronic Federal Tax Payment System and verify deposits.
- Monitor payroll providers.
- Act immediately when you discover a shortfall.
If you already owe
Ask about installment agreements and designating payments to trust fund taxes. See what to do if you owe back taxes. A tax lawyer should be involved before the interview with the revenue officer.
Sources
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This article is general legal information, not legal advice, and reading it does not create an attorney-client relationship. Laws differ by state and change over time; talk to a licensed attorney in your state about your situation.