Trust Fund Recovery Penalty
The IRS may impose the trust fund recovery penalty against any person who is responsible for and who willfully fails to collect, account for, or remit to the IRS any employee Federal tax withholdings. According to the Internal Revenue Manual, “responsibility is a function of duty, status and authority.” It’s called the trust fund recovery penalty because responsible persons are treated as holding the employee's taxes in trust until they are remitted to the IRS.
Employers are required to withhold federal income, social security, and Medicare taxes from their employees’ wages or salaries. These taxes are known as “trust fund taxes” and must be remitted by the employer to the Internal Revenue Service through electronic funds transfer of tax deposits or as payments made with the applicable tax returns.
If there is a willful failure to collect trust fund taxes, or if trust fund taxes are not truthfully accounted for and paid, or if the taxes are otherwise evaded or defeated in any way, the Internal Revenue Service may charge a trust fund recovery penalty and impose personal liability on any number of responsible persons. The penalty is equal to the amount of the trust fund taxes evaded, not collected, not accounted for, or not paid to IRS, and includes interest on the total amounts due.
If there is a willful failure to collect trust fund taxes, or if trust fund taxes are not truthfully accounted for and paid, or if the taxes are otherwise evaded or defeated in any way, the Internal Revenue Service may charge a trust fund recovery penalty and impose personal liability on any number of responsible persons. The penalty is equal to the amount of the trust fund taxes evaded, not collected, not accounted for, or not paid to IRS, and includes interest on the total amounts due.
Who Has to Pay the Trust Fund Recovery Penalty?
According to the IRS, any person or group who has the duty to perform and the power to direct the collection, accounting, or payment of trust fund taxes is personally responsible for the payment of trust fund taxes to the IRS. If the IRS can’t immediately collect the trust fund taxes from the employer or business, the IRS may take action against any responsible person or group if they acted willfully in failing to collect, account for, or pay the trust funds to the government.
For purposes of the trust fund recovery penalty, “willfully” means voluntarily, consciously, and intentionally. A responsible person acts “willfully” if the person was or should have been aware of the outstanding taxes and either intentionally disregarded the law or was plainly indifferent to its requirements. No evil intent or bad motive is required. The IRS considers the payment of any other business expense instead of trust fund taxes, including the payment of compensation to employees, to constitute willful behavior.
For purposes of the trust fund recovery penalty, “willfully” means voluntarily, consciously, and intentionally. A responsible person acts “willfully” if the person was or should have been aware of the outstanding taxes and either intentionally disregarded the law or was plainly indifferent to its requirements. No evil intent or bad motive is required. The IRS considers the payment of any other business expense instead of trust fund taxes, including the payment of compensation to employees, to constitute willful behavior.
The IRS may treat any person who had responsibility for certain aspects of the operations and financial affairs of the employer or business as a responsible person. Thus, it is possible for any of the following individuals to be a responsible person:
- An officer or an employee of a corporation
- A member or employee of a partnership or limited liability company
- 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, which may include accountants, trustees in bankruptcy, banks, insurance companies, or sureties
- Another corporation or third party payer
- Payroll Service Providers (PSP) or responsible parties within a PSP
- Professional Employer Organizations (PEO) (employee leasing companies) or responsible parties within a PEO
- Responsible parties within the common law employer (client of PSP/PEO)
Once the trust fund recovery penalty has been assessed, the IRS may seize any of the assets of the person or business (except for certain exempt assets) and collect any trust fund taxes that are owed. Further, trust fund recovery penalties are entitled to priority status and are not generally dischargeable in bankruptcy. Thus, trust fund recovery penalties will remain a permanent financial obligation of a responsible person until the trust funds have been repaid to the IRS, or until the responsible person has paid off any offer in compromise agreement for a lesser amount they may have negotiated with the IRS.
Third-Party PSPs & PEOs
Many employers outsource some or all payroll duties to third-party payroll service providers (PSP), which help to ensure compliance with a company's IRS filing and deposit requirements. However, in the event the third-party PSP fails to remit the trust fund taxes to the IRS, the employer still can be responsible for the deposit of Federal employee withholdings and the timely filing of returns. Depending on the facts and circumstances, and the type of third-party arrangement, an employer who uses a third-party PSP to perform Federal employment tax functions on its behalf may still be liable for trust fund recovery penalties, even if the third-party PSP caused the violation that resulted in the IRS’s assessment of the penalty.
A professional employer organization (PEO), sometimes referred to as an employee leasing company, is a service provider that enters into an agreement with a client to perform some or all of the federal employment tax withholding, reporting, and payment functions related to workers performing services for the client. A PEO also may manage human resources, employee benefits, workers compensation claims and unemployment insurance claims for the client.
Pursuant to the Tax Increase Prevention Act of 2014 (TIPA), a PEO that applies and is certified by the IRS may be considered the employer of any work site employee that performs services for any customer of the PEO. A certified PEO (and no other person) is treated as the employer liable for employment taxes with respect to wages paid by the certified PEO to a work site employee performing services for any customer of the certified PEO. The IRS's rules for its new certified PEO program are described in Revenue Procedure 2016-33.
Assessment of the Penalty
Once the IRS determines that a particular individual or company is a responsible person, the IRS will notify them of its intention to assess the trust fund recovery penalty. The individual or company then has 60 days (or 75 days for a person outside the U.S.) from the date of the IRS’s notice to appeal the assessment. If the individual or company fails to appeal the assessment within the required time period, the IRS will assess the trust fund recovery penalty and send the responsible person a notice and demand for payment. At that time, the IRS can begin collection efforts against the taxpayer’s property, including filing federal tax liens and commencing a levy or seizure action.
Avoid the Penalty
Business owners and other potentially responsible persons can avoid trust fund recovery penalties by making sure that all Federal taxes and other amounts withheld from employees' paychecks are collected, accounted for, and remitted to the IRS in a timely manner. Officers, directors, shareholders, members, managers and employees all have a vested interest and personal stake in making sure that all withholdings and other trust fund taxes are paid to the IRS. These individuals will not be protected by their organization’s limited liability shield under state law, and if the penalty is assessed, these individuals will not be able to file for bankruptcy protection to avoid personal liability for the trust fund recovery penalty.