IRS Trust Fund Recovery Penalty & Personal Liability

The Trust Fund Recovery Penalty (TFRP) holds any responsible individual personally liable if employment taxes are withheld but not paid to the IRS. It equals the unpaid amount and can be collected from the person’s assets, even if the funds were used for other expenses.

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Who Is Liable For The Trust Fund Recovery Penalty?

An individual who is responsible for ensuring that employment taxes are collected, accounted for, and paid over to the IRS, and willfully fails to do so may be subject to a civil penalty equal to the amount of the unpaid withholdings. This civil penalty, often referred to as the Trust Fund Recover Penalty (TFRP), may be imposed even if the individual uses the employment tax to pay other creditors or keep the business afloat. The TFRP permits the IRS to collect the unpaid withholding taxes from the assets of the responsible party.

How Does the IRS Determine Who is Liable for the Trust Fund Recovery Penalty?

In deciding whether to impose the Trust Fund Recover Penalty (TFRP), the IRS will focus on two key elements:

Is the individual responsible for collecting or paying withheld income and employment tax, or for paying collected excise tax? and
Whether the individual’s failure to collect or pay withheld income and employment tax, or failure to pay excise taxes was willful?

Who Is a Responsible Person?

The IRS defines a “responsible” person as a person or group of people who has the duty to perform and the power to direct the collecting, accounting, and payment of payroll taxes to the IRS. A responsible person can be an officer of a corporation, a partner, a sole proprietor, or an employee of any form of business.

A responsible person can also include a board member of a non-profit organization, another person with authority and control over funds to direct their disbursement, another corporation or a third party payer, such as a Payroll Service Provider (PSP), or Professional Employer Organization (PEO). In essence, anyone can be deemed a responsible party.

What Constitutes Willful Conduct?

In addition to being a responsible party, the IRS has to establish that the conduct was willful. The IRS employs a two prong test:

First, the IRS will determine whether the person was aware or should have been aware of the outstanding employment taxes.
Second, the IRS will determine whether the responsible person either intentionally disregarded the law or was plainly indifferent to its requirement.

For purposes of establishing willfulness, the IRS does not have to prove evil intent or bad motive. Thus, a responsible person who elects to use collected employment withholding taxes to pay creditors instead of remitting the taxes withheld to the IRS is considered to have acted willfully.

The Amount of the Trust Fund Recover Penalty & the Statutory Authority to Assess

The amount of the Trust Fund Penalty is equal to the amount of income tax withheld plus the employees’ portion of the withheld FICA taxes.The statutory authority for the assessment of the Trust Fund Recovery Penalty is 26 U.S.C § 6672, and may apply to more than one person. For example a partnership with three partners fails to collect and pay employee income end employment taxes. In this instance, the penalty could be assessed against all three partners. In addition, the IRS is not required to exhaust its remedies against the business before it can pursue the responsible parties. While the IRS cannot collect the tax twice, they are permitted to pursue both the entity as well as the responsible parties at the same time.

Employment Withholding Taxes and the “Trust Fund” Concept

The Internal Revenue Code §7501 imposes upon every employer the obligation to collect or withhold any internal revenue taxes and pay them over to the Internal Revenue Service. The Code section further requires that an employer is charged with the responsibility of safeguarding these funds by holding them in a special trust fund for the benefit of the U.S. Government.

The assessment process usually begins after the business fails to withhold, account for and pay over to the IRS, the collected employment withholding taxes.The process may also be initiated, where the business has failed to file payroll tax returns.

Process for Assessing The Trust Fund Recover Penalty

The IRS will initially take steps to identify the officers, partners, members or employees who had a duty to collect over the taxes. In this regard, the IRS will in all likelihood request and examine the Articles of Incorporation, Bylaws of the corporation ,operating agreement and other official documents, as well as the payroll records. The IRS may also examine the minute books of the corporation, cancelled checks and bank records (i.e. signature cards, Bank Statements, ATM cards) and Tax Returns.

Business and financial records are used to identify the names of the persons responsible for filing returns and the payment of taxes and also those persons who have authority to sign checks, deposit money or make loans on behalf of the corporation.

The business records may be sufficient to support a finding of fact that a person is a responsible person.

For purposes of making a determination of whether the individuals conduct was willful, business records are often times probative, where there is evidence that funds have been diverted.

The IRS Interview Process

In addition to examination of business records, the Internal Revenue Service will interview witnesses in order to determine whether the witness had a duty to account for, collect and pay over trust fund taxes and whether he or she willfully failed to perform any of these duties. The IRS will also speak with non-responsible employees, who may have knowledge of the business and its decision making process for purposes of identifying a responsible party and whether the responsible party’s conduct was willful.

Many business owners, shareholders, officers, directors and other employees unwittingly attend the IRS interview without first consulting with a tax attorney. Oftentimes an individual may be lulled into thinking that the interview relates to the entity and in its inability to meet its payroll tax obligations.

The individual is confident that by attending the interview and providing the requested documents, that the IRS will conclude the business is incapable of satisfying the outstanding payroll tax liability and the matter will be concluded. The individual is stunned to learn, usually after the interview, that he/she was the target of the interview and that the IRS used the individual’s responses to questions during the interview to support a finding that the individual is a responsible person, and also that the conduct was willful.

If the IRS requests that you attend an interview, you should never attend such an interview without being accompanied tax attorney.

There are number reasons why you need legal representation:

The IRS may have already decided the issue before you arrived and is simply looking to shore up the determination. In this case, they may be looking to validate their preliminary determination and unwilling to hear your side of the story;
The IRS may be considering the 75% civil fraud penalty, and are attempting to gather evidence to support such an assessment; and
The business records examined by the IRS as well as your responses during the interview may serve asa catalyst for a referral to the Criminal Investigation Division of the IRS.

There may be circumstances where “reasonable cause” can be raised as a defense. However, the different Circuits of the United States Court of Appeals have split on whether the reasonable cause defense negates a responsible person’s willfulness and is a defense to the Trust Fund Recovery Penalty. Even in those Circuits that permit the reasonable cause defense, the defense is narrowly applied. The take away here is that with rare exceptions, the reasonable cause defense will not preclude the assessment of the the Trust Fund Recover Penalty (TFRP).

If you are involved in a business that is delinquent in its payroll tax obligations or has failed to file regular payroll tax returns, there is a strong probability you will be contacted by the IRS sometime in the future to explain why you are behind in your payroll taxes o failed to file the required returns. The IRS will typically request that you furnish them with your business records and that you also attend an interview at the IRS office. These requests strongly suggest that the IRS is targeting you and considering the assessment of the the Trust Fund Recover Penalty (TFRP). In more serious cases, the IRS may be considering the Civil Fraud or other penalties or considering a referral to the Criminal Investigation Division. If you have been contacted by the IRS do not try to handle the problem yourself. Your decision could result in dire and life altering consequences affecting you, your family and reputation.

The IRS has stepped up the investigation and prosecution of individuals who have treated collected Employee Withholding Taxes as their personal piggy bank. If you are on the radar with the Internal Revenue Service, you need to secure the services of a seasoned tax attorney.

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