The Trust Fund Recovery Penalty: When You’re Personally Liable for Business Payroll Taxes

If your business owes payroll taxes to the IRS, there’s a damn good chance you’re going to end up being personally liable.?

When you own a business, you’re required to take FICA taxes from your employees’ paycheck. You have to keep your share and your employees’ share of FICA taxes in a trust and later pay the taxes from the trust to the IRS.?

These are called Trust Fund taxes.

But when you run a business, there are times when cashflow is tight.

What if you decide to use the payroll funds that you’re holding in trust to pay to the IRS on behalf of your employees to pay a vendor who has materials you need instead??

The IRS calls that STEALING.?

And they punish that by making one or more people within the company personally liable for the trust fund taxes that weren’t paid.

It’s called the Trust Fund Recovery Penalty or “TFRP”.

But who within the company is personally liable??

And how does the IRS decide??

If the company is a sole proprietorship and you’re the owner, many times it’s simple - you’ll be assessed the Trust Fund Recovery Penalty.

Other times, it’s more complicated

What if you own the business with your spouse? Which of you are held personally liable??

What if your comptroller was supposed to pay the taxes but they didn't? Are you, as the owner still personally liable? Or is the comptroller??

It becomes even more difficult when there are multiple people involved in paying the payroll taxes.

Who is Assessed Personal Liability with the TFRP

The IRS looks at two factors to determine that someone is personally liable: (1) who was “responsible” for paying the trust fund taxes; and (2) did the responsible person willfullly fail to collect or pay the taxes.?

Both of these factors must be present for the IRS to assess the TFRP.

If multiple people are assessed the TFRP, they’re jointly and severably liable for the taxes meaning each individuals owes the entire amount but the IRS can’t collect more than the total amount owed.?

Here are the five most important aspects to understand when it comes to personal liability for business payroll taxes, also known as the Trust Fund Recovery Penalty.?

#1: Who was Responsible for Paying the Trust Fund Taxes?

The IRS and courts define a person as “responsible” for paying the payroll tax as any person whose duty it was to collect and make the tax payments. A responsible person may also be the person with the power to direct that these duties be performed. Specifically, could the person make the decision to pay other creditors before the IRS??

The IRS considers the individual’s duties, corporate status, signature authority over the business’s accounts, and ability to hire and fire employees.?

#2: Did the Responsible Person Willfully Not Pay?

The responsible person must also have been willful in not paying the trust fund taxes to the IRS.?

Failure to pay is considered willful if it's voluntary, conscious, and intentional.

Willful may mean that the responsible person chose to pay other creditors instead of the IRS, even though the person knew, or recklessly disregarded, that the business was not paying the payroll taxes.?

Neither evil intent nor bad faith are necessary to determine willfulness.?

#3: The Consequences

The penalty for failing to pay the IRS trust fund taxes is called the Trust Fund Recovery Penalty.?

The IRS aggressively pursues these taxes and imposes a personal liability equal to the total amount of unpaid taxes.

Once again, that includes any income taxes withheld from an employee’s paycheck plus the employee’s Social Security and Medicare contributions.

#4 How Long Does the IRS Have to Make Someone Personally Liable?

The IRS only has 3 years to assess the Trust Fund Recovery Penalty for the unpaid payroll taxes. The clock starts when taxes are due in April of the following year.?

For instance, if your business was supposed to deposit trust fund taxes in June 2014, the IRS has three years from April 15, 2015, to assess personal responsibility.

If the IRS doesn’t assess the personal penalty by April 14, 2018, it’s over.?

If you haven’t already been held personally liable, you won’t be assessed the TFRP.?

After the statute of limitations runs, it’s illegal for the IRS to assess the TRFP or investigate who may be personally responsible.

There are exceptions, of course.?

If the business hasn’t filed a payroll tax return, the clock doesn't start. In the instance above, even if you haven’t deposited payroll taxes owed for June 2014, the three year statute of limitations does not begin in April of 2015.

It doesn't start until the return is filed.

#5 Professional Guidance Early On is Key

Once the IRS determines that someone is personally liable for the company’s failure to deposit payroll taxes, it’s not set in stone, but you have to take advantage of the options you have to disagree, and you must do it timely.?

If the IRS determines that you are liable for the TFRP, you’ll receive Letter 1153 stating that they intend to assess the TFRP against you. You have 60 days to request an appeal.

If you do not respond timely, you’re determined to be personally liable, and you’ll receive a notice indicating that you owe taxes just like you would with any tax debt.

Clients tell me all of the time that they’ve been hit with a TRFP and should not have been held personally responsible for payroll taxes.?

The first question I ask is, “Did you challenge the initial proposed assessment?”.

Invariably, the answer is no.?

Once the TFRP is assessed and the appeal deadline has passed, you still have some ability to challenge the TFRP, but the best way to do so is gone which is why having a tax professional involved early on is so important.

If you miss the 60-day window to file an administrative appeal and you've already been assessed the personal tax, your next option is to file a Doubt as-to-Liability Offer in Compromise (DATL), alleging that the IRS should agree to accept a portion of the amount owed because you shouldn’t have been assessed the TFRP.?

Alternatively, if you’ve already made payments on the Trust Fund Recovery Penalty, you can file a claim for a refund and similarly request a review of the TFRP assessment, but it’s never as effective as filing that initial appeal.

TL;DR:?

• Employers must collect and remit payroll taxes, including Social Security and Medicare, to the IRS.?
• Failing to do so can result in personal liability under the Trust Fund Recovery Penalty (TFRP).?
• The IRS can hold any "responsible person" personally liable if they willfully failed to pay.?
• This penalty covers the total unpaid FICA taxes that the business debited from the employees’ paychecks to be paid to the IRS.?
• The IRS has three years to assess personal responsibility.?
• Professional tax guidance is crucial to navigate the process and challenge assessments effectively.

PS: Have you or your client been hit with the Trust Fund Recovery Penalty?

Tell us about your experience in the comments!