Trust Fund Recovery Penalty
The IRS may be kinder and gentler after the 1998 IRS Restructuring and Reform Act, but that certainly doesn’t seem to be the case with payroll taxes. When a business is doing poorly, a small business needs to make a decision – to reduce staff or not pay the bills. Oftentimes, a struggling business owner, for emotional or other reasons, may not want to lay off employees. At the same time business expenses need to be paid to keep the business running. A tempting solution can be to dip into their employees’ payroll tax funds to pay off business expenses. This ends up being a recipe for disaster. The struggling business gets behind on payroll taxes, continues to incur new payroll taxes and business expenses, and is unable to catch up. Eventually when the business shuts down, the owner will be personally liable for some of the payroll taxes. The IRS will prioritize collection of these taxes from the owner and other responsible parties.
Payroll Taxes vs. Trust Fund Taxes
Employers must withhold federal income taxes, social security, and Medicare tax from their employees’ pay. All of the federal income tax and ½ of the social security and Medicare taxes are paid by the employee, while the employer pays the other ½. The employees’ portion is referred to as trust fund taxes. Payroll tax is comprised of trust fund and non-trust fund taxes.
Failure to Pay Trust Fund Taxes
The IRS considers it a theft of government money when employers dip into the trust fund portion and fail to pay these taxes to the government. And it’s easy to see why – the employees are still able to deduct their payroll taxes on their tax returns, while the government is left holding an empty bag.
When an employer fails to pay the trust fund portion, the IRS has the authority to assert a trust fund recovery penalty (TFRP). A TFRP may be asserted against those determined to have been responsible and willful in failing to pay over the tax. The persons responsible could include:
- an officer or an employee of a corporation,
- a member or employee of a partnership,
- 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,
- another corporation or third-party payor,
- payroll service providers (PSP) or responsible parties within a PSP,
- professional employer organizations (PEO) or responsible parties within a PEO, or
- responsible parties within the common law employer (client of PSP/PEO).
Whereas when an employer fails to pay the non-trust portion (i.e., the employer’s share of payroll tax), the IRS may only hold the company responsible, and the liability generally does not extend to the owners or partners.
Trust Fund Recovery Penalty Process
TFRP cases begin when the employer files a Form 941 with a balance due or an IRS FTD (Federal Tax Deposit) alert is created. FTD alerts identify employers that have not made current deposits or made them in substantially reduced amounts.
The alerts are then routed to a Revenue Officer (RO) and a pre-contact analysis is performed. If the analysis shows that the funds have been paid after the alert was created, the RO will close the case. Otherwise, the revenue officer is required to make initial contact with the taxpayer within 15 calendar days. During the initial contact, the RO is required to explain the TFRP and provide a copy of the TFRP calculation. The IRS will then conduct an interview and record their notes on Form 4180. This is the RO’s time to begin asking questions and gathering documents for purposes of asserting the penalty.
Taxpayers are encouraged to retain a representative to complete the interview on their behalf. The IRS cannot force a taxpayer to attend absent the issuance of a summons.
The RO will then assemble the core evidence necessary to assess a TFRP, such as the interview notes on Form 4180, business operating agreement and certificate of formation, bank signature authority cards, and a sampling of cancelled checks showing payments to other creditors instead of the government.
After all responsible persons are interviewed and documents are reviewed, the RO will submit a recommendation of assertion or non-assertion of TFRP on Form 4183. If the RO group manager confirms, a Letter 1153 and Form 2751 will be issued, notifying each responsible person of the proposed assessment.
If you are the recipient of a Letter 1153 and Form 2751, you should not sign the form without talking to an attorney! Form 2751 waives the restriction on notice and demand. You waive your right to a 60-day notice and give the IRS the authority to assess the TFRP immediately and initiate collections action.
Relief from Trust Fund Recovery Penalties
A Trust Fund Recovery Penalty asserted against you can be overwhelming. While there may be multiple responsible parties, the IRS has the authority to collect all the tax from any responsible individual (joint and several liability). That individual would then have a right to bring suit against the other responsible parties to pay their portion in civil court.
Statutory prerequisites. The first step if you’ve been asserted a TFRP is to determine whether you meet the statutory prerequisites – responsibility and willfulness. There are a multitude of TFRP cases where the tax court has found that the IRS overreached in asserting these penalties against parties who were not responsible.
Statute of limitations. Absent fraud, or failure to file, the TFRP must be assessed within 3 years of the date the Form 941s were filed.
Payment strategies. Often a company will owe both trust fund penalties as well as income taxes (non-payroll). Since TFRPs are asserted on the individual members and pursued aggressively, it would be advantageous to pay the trust fund portion first before paying the income tax.