Could You Be Hit with the Trust Fund Recovery Penalty?

There is a harsh tax penalty business owners could pay personally if they own or manage a business with employees. It is called the Trust Fund Recovery Penalty and it applies to the Social Security and income taxes required to be withheld by a business from the wages of its employees. This article looks at the risk and explains how business owners, managers and other involved parties can avoid incurring the penalty.

Because taxes are considered property of the government, the employer holds them in “trust” on the government’s behalf until they are paid. The penalty is also called the “100% penalty” because the person liable and responsible for the taxes can be penalized 100% of the taxes due. Accordingly, the amounts the IRS seeks when the penalty is applied are usually substantial, and the IRS is aggressive in enforcing the penalty.

A wide-reaching penalty

The Trust Fund Recovery Penalty is a dangerous tax penalty because it applies both to a broad range of actions and to a wide range of people involved in a business.

Here are some questions and answers to help you avoid incurring the penalty.

What actions are penalized? The Trust Fund Recovery Penalty applies to willful failures to collect or truthfully account for and pay over Social Security and income taxes required to be withheld from employees’ wages.

Who is at risk? The penalty can be imposed on anyone “responsible” for collection and payment of the tax. This has been broadly defined to include corporate officers, directors and shareholders who are under a duty to collect and pay the tax, and a partnership’s partners or any employee of the business with such a duty. Even voluntary board members of tax-exempt organizations, who are exempt from responsibility, may be subject to this penalty under certain circumstances. In some cases, responsibility has even been extended to family members close to the business, and to attorneys and accountants.

According to the IRS, responsibility is a matter of status, duty and authority. Anyone with the power to confirm taxes can be paid may be responsible. There is often more than one responsible person in a business, but each is at risk for the entire penalty. You may not be directly involved with the payroll tax withholding process in your business. If you have the authority to pay taxes but learn of a failure to pay taxes and allow payments to creditors and others, you become a responsible person.

Although a taxpayer held liable can sue other responsible people for contribution, this action must be taken after the penalty is paid, entirely on his or her own. It is not part of the IRS collection process.

What is considered “willful?” For actions to be willful, they do not have to include an overt intent to evade taxes. Simply bending to business pressures and paying bills or obtaining supplies instead of paying withheld taxes due to the government is willful behavior. The IRS specifically defines “willfully” in this instance as “voluntarily, consciously and intentionally” paying other expenses instead of the withholding taxes.

Regardless of delegating these responsibilities to someone else does not mean you’re off the hook. Your failure to deal with the task yourself can act as the willful element.

Never borrow from taxes

Under no circumstances should you ever fail to withhold taxes or “borrow” from withheld amounts. All funds withheld from employee paychecks should be paid to the government in full and on time. Contact us with any questions about making tax payments.

The HoganTaylor Tax Services

If you have any questions about the content of this publication, or if you would like more information about HoganTaylor's Tax services, please contact Tony Otto, Lead Tax Partner. You may also contact Denise Felber, Tax Partner.

INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.