The Trust Fund Recovery Penalty (“TFRP”) was created to encourage prompt payment of withheld income and employment taxes such as social security taxes, railroad retirement taxes, or collected excise taxes. Typically, the employee’s money is held “in trust” until the business owner or responsible party makes a tax deposit to the IRS for the amount owed, e.g. tax withheld on IRS Form 941 Employer’s Quarterly Federal Tax Return.
Problems arise when a business owner or person responsible for collecting or paying withholds these taxes from employees but does not pay the same over to IRS. Some businesses may ignore payment because they are struggling to make ends meet or choose to spend the withheld money elsewhere. Other businesses are simply unaware of the tax obligation or the person responsible takes action contrary to what the business is aware of. Either way, the IRS will seek payment from the business and also look to apply personal liability for the TFRP to certain people who are responsible for payment and willfully do not make payment.
The TFRP penalty for this oversight is equal to the unpaid balance of the trust fund tax, i.e. the unpaid income taxes withheld plus the employee’s portion of the withheld FICA taxes. This makes the individual responsible for the amount that the company did not pay. The one or more individuals possibly responsible for collecting and paying the taxes will be identified by the IRS and an investigation or interview will take place. Generally, the IRS needs to establish the following two elements by each individual: (i) willfulness; and (ii) responsibility. Time deadlines on IRS notices should not be ignored, and a tax attorney may be worth consulting or engaging.
Business owners or key employees can avoid the TFRP by making sure all employment taxes are collected and paid to the IRS in a timely manner. If you are uncertain of where your business stands on employment taxes, contact your accountant, CPA, or a tax attorney.