Are you an owner or employee of a business that is delinquent with employment taxes? If so, watch out! It is possible that you will be held personally liable for what is called the Trust Fund Recovery Penalty.
What is the Trust Fund Recovery Penalty?
In short, the Trust Fund Recovery Penalty is a penalty that can be asserted against individuals, and is equal to the amount of money actually withheld from employees’ paychecks and not turned over to the IRS. The trust fund tax is comprised of the withheld income tax and the employee’s share of the Medicare and Social Security taxes (i.e. FICA taxes). The trust fund tax is not comprised of the employer’s share of the Medicare and Social Security taxes and, instead, is only comprised of the employees’ share. Furthermore, penalties and interest assessed against the underlying business entity are not considered trust taxes.
The tax is called a trust fund tax because the individuals in control of the business entity are supposed to hold onto the employees’ withheld money in trust (as it is not the employer’s money) until it is remitted to the Internal Revenue Service in the form of the employment tax (usually Form 941). Consequently, the Internal Revenue Service basically views it as theft when the taxes are not remitted because the employer is in essence taking funds that do not belong to them and, instead, is presumably using the funds to pay other business expenses (or to pay themselves).
Who Can be Held Liable?
Accruing an employment tax liability is very detrimental because the tax laws (26 USC Sec. 6672 aka IRC Sec. 6672) allow the IRS to assess the trust fund portion of the employment tax liability against those individuals that they determined have the responsibility of collecting and paying the taxes on behalf of the business, but instead willfully evaded or attempted to evade the tax payment by not remitting it. With regards to the trust fund taxes, the fact that the business may be a corporation or an LLC does not insulate the responsible individual(s) from being personally assessed with this liability. In fact, the law is primarily aimed at individuals in control of a corporation or an LLC.
There is no Trust Fund Recovery penalty for owners of sole proprietorships and partnerships, as they are already personally liable for all of the employment tax liability, including the amount withheld from the employees’ paychecks, the employer matching portion of the tax liability, penalties, and interest. However, it is possible for non-owner employees of sole proprietorships and partnerships to get stuck with a Trust Fund Recovery Penalty (see below for discussion on potential personal liability for non-owner employees).
The tax laws provide that responsibility is a matter of status, duty, and authority. Consequently, a determination of responsibility is dependent on the facts and circumstances of each case. Some factors that are considered are duty to perform, power to direct the act of collecting trust fund taxes, accountability for and authority to pay trust fund taxes, and authority to determine which expenses will or will not be paid. The full scope of authority and responsibility is primarily contingent upon whether the individual had the ability to exercise independent judgment with respect to the financial affairs of the business.
The tax code and courts have determined that willfulness, in this context, means intentional, deliberate, voluntary, reckless, and knowing, as opposed to simply accidental. Willfulness does not require an evil intent or bad motive. In order to prove willfulness, the government generally must demonstrate that a responsible person was aware, or should have been aware, of the outstanding taxes and either intentionally disregarded the law or was plainly indifferent to its requirements. This indifference is clarified in that a responsible person’s failure to investigate or correct mismanagement after being notified that withholding taxes have not been paid satisfies the requirement of willfulness.
Although there are some exceptions, generally speaking, owners, managing members, and officers of businesses that are aware or should have been aware that the trust taxes were not being paid meet the criteria of “willful and responsible,” and can be held personally liable.
Can a Non-owner Employee be Held Liable?
Yes! It is very possible for a non-owner employee to be held personally liable. However, in order to do so, the government must establish that the non-owner employee is not acting solely under the dominion and control of others, and, instead, is in a position to make independent decisions on behalf of the business entity.
Note that non-owner employees who are involved with the finances of the business (e.g. they pay some or all of the bills or have some input into which bills should be paid) are at risk of personal liability if the IRS perceives that they have some level of control over the company’s finances. The IRS’s perception in this context can sometimes be incorrect, and the methods that they use for investigating form a trap that can sometimes ensnare the innocent.
For this reason, it is strongly recommended that non-owner employees who are involved with the finances of a business immediately seek the counsel of an experienced tax attorney whenever employment taxes are not being paid. If the IRS is already investigating their employer for unpaid trust taxes, then the need for counsel is even greater. Very often, the owner of the business will not want her employee to face personal liability for the company’s failure to pay these taxes and will be willing to pay for any legal fees for the employee’s defense.
What is the Process for Personal Assessment?
An IRS Revenue Officer will first conduct an investigation that typically involves interviewing potentially responsible individuals (sometimes referred to as a “4180 interview), and reviewing bank signature cards, cancelled checks, bank statements, and other financial information. Once the Revenue Officer completes his investigation, he will issue a letter proposing the assessment of the trust fund recovery penalty against the individual(s) whom he believes fit the criteria of willful and responsible. This letter is also known as Letter 1153.
Once the assessment is proposed (via the Letter 1153), the individual(s) will have the opportunity to file a timely protest to the assessment if they disagree with the IRS’s determination. If the individual(s) does not protest the proposed assessment within the allotted time, the assessment will be made—typically 90-120 days after the date on the 1153 letter. At that point, the assessed individual will have an IRS Trust Fund Recovery Penalty liability under his or her social security number. Subsequent IRS notices sent to the individual will often refer to the liability as a “civil penalty” or a “6672” liability.
If the individual files a timely formal protest, the individual will have to demonstrate that he was not willful and responsible for the failure to pay employment taxes and, accordingly, should not be assessed. The protest of the assessment will then go to an Appeals Officer who is tasked with reviewing all facts and circumstances of the case in order to make the final determination based on everything presented. If the outcome of the appeal is not favorable to the individual, the individual may file a petition with Tax Court for further review.
Having an experienced tax attorney on your side throughout this process can be extremely beneficial for a couple of reasons. First, this will minimize the chances of the IRS making an erroneous proposal of the Trust Fund Recovery Penalty (thus alleviating any need, stress, and cost of a protest). Second, in the event that a protest is warranted, a good tax attorney can give you the best chances of prevailing at the appeals level. Note that even if you fail to outright win with this type of appeal, you may still be able to reach a settlement based on “hazards of litigation” with the Appeals Officer for significantly less than the proposed amount of Trust Fund Recovery Penalty.
Is the Trust Fund Recovery Penalty in Addition to What the Business Owes?
Yes and no. In the sense that the IRS has the right to collect the trust taxes from the responsible individual in addition to the business, it is an additional liability. However, in the sense that the IRS may only collect the trust taxes once, it is not an additional liability.
Confused? You aren’t alone. This concept is frequently misunderstood by non-tax professionals, and even by some inexperienced tax pros. The assessment of the Trust Fund Recovery Penalty effectively makes the unpaid trust taxes a joint and several liability of the business and the responsible individual(s), meaning that the IRS may collect none of it, some of it, or all of it from either the business or the individual(s). However, the IRS may not collect it more than once. To illustrate, if the IRS collects $1,000 in trust taxes from the business, the individual’s liability will also be reduced by $1,000 and vice versa.