Trust Fund Recovery Penalty – When YOU May be Held Personally Liable for Someone Else’s Taxes

Trust Fund Recovery Penalty: What is it? When can you be held personally responsible for unpaid employment and other “Trust-related” Federal Taxes?

First, let’s get the Internal Revenue Code out of the way. According to IRC § 6672(a), any person required to collect, account for, and pay over any tax imposed, who willfully fails to collect such tax, or properly account for and pay over such tax, or willfully attempts in many manner to evade or defeat any such tax or the payment thereof, in addition to other penalties provided by law, shall be liable to a penalty equal to the amount of the tax evaded, or not collected, or not accounted for and paid over. (note that this is not a direct citation of the Code—it was slightly modified for clarity).

Wow, what does all that mean? Well, it means if you are any individual responsible for collecting, accounting for, and/or paying a number of types of Federal tax (the ones that are deemed a “trust fund” tax, discussed later), you can be personally liable for up to 100% of the tax that should have been paid, plus other penalties. Yes, this means even if you are only an employee, but you have accounting responsibilities and/or are a signatory on a bank account, you may be held personally liable if the taxes are not collected, accounted for, and/or paid to the appropriate agencies. This part of the IRC (IRC § 6672(a)), also referred to as the Trust Fund Recovery Penalty, or TFRP (because you are effectively holding such taxes in “trust” for the government, and then required to remit them by due dates), penetrates the liability protection afforded by LLCs and Corporations, and applies whether the company is still in operation or shut down.

Who is a responsible individual? According to the IRS, they include but are not limited to:

• An officer, shareholder, member, or employee (any sole proprietor is, by default, a responsible individual)
• A member of a Board of Trustees for a nonprofit
• Any person with authority and control over funds to direct their disbursement (HELLO! CPAs, accountants, bookkeepers…)
• Any corporate or third-party payer
• Payroll service providers or any responsible parties within a payroll service provider
• Professional employer organizations, or any responsible parties with such organization
• Responsible parties within the common law employer

Another factor is that willfulness must exist. For willfulness to exist, the responsible person:

• Must have been, or should have been, aware of the taxes due, AND
• Either intentionally disregarded the law or was plainly indifferent to its requirements (no evil intent or bad motive required)

For the Trust Fund Recovery Penalty to apply, you must be a responsible individual AND act willfully.

Who is this most likely to impact? The primary area of liability is concerning payroll taxes and the “trust fund” portion, which is generally the amount withheld from employee wages. It does not apply to direct taxes, such as the employer portion of FICA. If payroll taxes should have been withheld, or were withheld, and were not accounted for and/or paid to the appropriate revenue agency in accordance with regulations, you can personally be on the hook for these taxes, even if you are just a payroll clerk with a responsibility of remitting such tax payments. Scary. More bad news—the Trust Fund Recovery Penalty is not dischargeable in bankruptcy and is nondeductible. And what if you are a household employer, failing to treat your household employee as an ordinary employee? TFRP can kick in!

Let’s take a look at an example:

Company A is struggling with cash flow but needs to continue paying its employees and vendors to remain operational (a going concern). In an effort to do so, the payroll clerk and controller are asked by the Corporate President to continue paying employees and vendors, but not to remit payroll taxes, including those withheld from employee checks. The payroll clerk and controller also meet the criteria of responsible individuals. Based on what has been discussed above, each of the involved parties—the payroll accountant, controller, Corporate President, and likely others—may be subject to the Trust Fund Recovery Penalty and could be held personally liable for payment of these taxes. Why? Because the company has withheld taxes from employee checks and has been entrusted by the government to timely remit those taxes.

For the above example, an “out” may exist if the employee’s function was solely to pay bills as directed by a superior, rather than having any actual authority or discretion as to which creditors would or would not be paid. But, this should not be considered a blanket rule. Keep in mind, the general definition of a responsible person is fairly broad, as stated in Brounstein vs. U.S. (3d Cir. 1992):

• A responsible person under section 6672(a) is a person required to collect, truthfully account for or pay over any tax…”Responsibility is a matter of status, duty, or authority, not knowledge.”…While a responsible person must have significant control over the corporation’s finances, exclusive control is not necessary. In determining whether an individual is a person responsible for paying over a tax, courts also consider (1) contents of the corporate bylaws, (2) ability to sign checks on the company’s bank account, (3) signature on the employer’s federal quarterly and other tax returns, (4) payment of other creditors in lieu of the United States, (5) identity of officers, directors, and principal stockholders in the firm, (6) identity of individuals in charge of hiring and discharging employees, and (7) identity of individuals in charge of the firm’s financial affairs.

Sorry, even if you feel your hands are tied by a superior, but you meet the qualifiers of a responsible individual, you may very well be subject to the Trust Fund Recovery Penalty. The IRS will attempt to apply it to any responsible individual, but it can only be applied and collected once for the given penalty. If the tax is partially paid, the TFRP is reduced. If fully paid, the TFRP is eliminated. If one responsible individual pays, then it relieves all other responsible individuals of the liability.

What are some warning signs that you could become subject to IRC § 6672(a)—aka, the Trust Fund Recovery Penalty?

• You are a responsible individual
• Your company is not paying taxes due as required by law, especially withheld payroll taxes

If this scenario exists in your position as an officer, shareholder, member, accountant, employee, Board member, etc., a siren should be sounding in your head. You may be held personally liable for these taxes, even if you leave the company and/or it ultimately shuts down.

Fortunately, the Trust Fund Recovery Penalty must be assessed and collected in the same manner as taxes—three years after the return to which it relates was filed, unless it is fraudulent, in which case no statute of limitations exists. Furthermore, the IRS must first alert the taxpayer/responsible party before assessment occurs, using Letter 1153.

Takeaway: If you are or think you may be a responsible party, make sure you do not become subject to the Trust Fund Recovery Penalty. If circumstances arise that cause concern, it may be time to consider making a significant decision and minimizing your exposure to the penalty by leaving or disengaging from the organization.

Sincerely,

Greg Bennett, CPA