The Trust Fund Recovery Penalty is a very severe set of rules that are meant to encourage voluntary compliance with our payroll tax laws.
Payroll taxes includes the income tax and Federal Insurance Contributions Act (“FICA”) taxes that are withheld from every employee’s paycheck. It also includes the employer portion of FICA. The business pays these taxes to the IRS on a weekly, monthly, quarterly or annual basis. The frequency depends on the size of the employer’s payroll.
Income tax withholding is based on information provided to the employer on Form W-4. This amount appears in box 2 of Form W-2 and is reported annually on personal income tax returns (Form 1040).
FICA is made up of 6.2% for Social Security and 1.45% for Medicare (7.65% in total). These amounts are matched by the employer, bringing the total to 15.3%.
In general, employers who withhold federal income tax, social security or Medicare taxes must file Form 941, Employer’s Quarterly Federal Tax Return, each quarter. In addition, employers report FUTA taxes by filing Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return.
Trust Fund Taxes
The amounts withheld by an employer from the employees of the business (income tax, plus the employee’s share of FICA) are held by the employer in trust for the government. Hence, these are known as “Trust Funds Taxes.”
Trust Fund Recovery Penalty
The IRS imposes a Trust Fund Recovery Penalty when a business fails to submit Trust Fund Taxes. The penalty is 100% of the tax.
The Trust Fund Recovery Penalty is imposed on anyone who fails to submit payroll taxes to the government. The IRS will assess this penalty against anyone deemed to be a “responsible person.”
The IRS has the power to levy bank accounts, retirement accounts and other assets from responsible parties in order to collect the penalty. Anyone who is considered to be a responsible party will have joint and several liability for the penalty. In other words, the IRS may collect the penalty from any and all responsible parties. There is no requirement for the IRS to collect from the business first.
The IRS also has the power to collect unpaid Trust Fund taxes from lenders who loaned money to cover the payroll of a business knowing that the business will not deposit its payroll taxes with the government. This provision sometimes catches family members who lend money to a family business with cash flow problems.
Payroll Tax and the Responsible Person
The IRS and the courts define “responsible person” broadly. The term may include owners, partners, bookkeepers, key employees or anyone else responsible for the collection, accounting and payment of payroll taxes to the government. Accounting firms, parent companies and purchasing companies may also be considered responsible parties.
Charitable volunteers or board members of non-profit organizations have been held liable for the Trust Fund Recovery Penalty if they are deemed to be responsible parties.
Processing payroll without signature authority over the bank account is considered an administrative function. It is not indicative of responsibility for this purpose.
Georgia CPA Pointer: The responsible party is usually the person with the ability to decide who gets paid. Signature authority over the bank account is the primary proof of responsibility. Therefore, it is critically important to restrict signature authority over the bank account whenever possible in order to limit responsibility for payroll taxes.
Willfulness and the Trust Fund Recovery Penalty
The Trust Fund Recovery Penalty is only assessed when the failure to account for and remit payroll taxes to the government is willful. Willfulness is deemed to exist when money withheld from employees as taxes is knowingly and intentionally used to pay the operating expenses of the business, or for other purposes.
The fact that there are insufficient funds to pay both employees and payroll taxes is not an excuse.
Negotiating with the IRS over Trust Fund Taxes
The IRS will aggressively pursue payroll tax cases and impose the Trust Fund Recovery Penalty whenever possible.
When faced with an IRS examination of payroll taxes, consider these strategies:
- Obtain copies of IRS records of the examination under the Freedom of Information Act (FOIA). This may tell you who the IRS thinks is the responsible party in the case. Then develop your defense.
- Get copies of canceled checks and bank signature cards to identify who at the business has signature authority.
- Have an attorney interview employees or former employees to identify their responsibilities. Obtain affidavits when possible.
In the worst case, the business may never be able to pay its payroll taxes to the government. If so, the business may be no longer viable and it may be better to shut it down. Closing the business reduces the total tax liability to only the Trust Fund portion of the tax debt. The owners may then be eligible for an Offer in Compromise for their share of the penalty.
Criminal Tax Cases
While criminal payroll tax cases are not common, the IRS will prosecute these cases under the right set of facts. In particular, repeated misuse of payroll taxes at different businesses will probably suggest a criminal level of activity. Likewise, lavish lifestyles, expenses homes, boats, planes, and exotic cars will often be held against the responsible party if the case goes to trial.
For a discussion on other types of IRS penalties, along with a detailed discussion on penalty abatement, see our Guide to IRS Tax Penalties.
You are welcome to call our Atlanta-based accounting firm at 678-235-5460 to discuss your payroll tax questions. We work with small businesses throughout Georgia and across the country.
Massey and Company is a boutique CPA firm located in Atlanta, GA, serving the needs of small businesses and individual taxpayers. Our services include tax preparation, tax planning, taxpayer representation before the IRS and state taxing authorities, audit defense, sales taxes, monthly bookkeeping and accounting.
Our office is in the Buckhead – Sandy Springs area of Atlanta, which is an advantage to those looking for a local firm to handle their tax matters.
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