Trust Fund Recovery Penalties: Not to be taken lightly

When employment taxes are not paid the Trust Fund Recovery Penalty and criminal tax charges can derail a business.

It's common for entrepreneurs to take out a loan to finance an expansion. For one of these business owners, an asset purchase was partially financed with a bank loan. Tough times resulted in the business missing loan payments. This violated the loan agreement and triggered a lockbox takeover.

Then things got even worse. Receivable placed in a lockbox were not used to pay employment taxes. The IRS assessed the owner and CEO with a trust fund recovery penalty. This is frequently called the 100 percent penalty, because it equals the unpaid tax balance. This generally includes two things:

  • Income taxes withheld from employee paychecks; and
  • The employer portion of FICA taxes - Social Security (6.2 percent) and Medicare (1.45 percent).

For many years, the business owner has litigated who was responsible for making the payments. The case has wound its way to the U.S. Court of Appeals for the Sixth Circuit. The IRS points to the fact that the owner still signed company checks after obtaining creditor approval. A decision is pending.

Personal Liability for Trust Fund Recovery Penalties

In other cases, a business may make a strategic decision to forego a trust fund payment in one quarter with the thought things will get better and the shortfall will be repaid. But this is extremely risky.

While this information is a bit dated, the TRFP assessments each year from 2006 - 2011 were more than four million dollars. This illustrates the close scrutiny paid to employment taxes. Unlike defaulting on other business debts, the failure to pay employment taxes results in personal liability regardless of business structure.

Section 6672 of the Internal Revenue Code assigns liability when an individual responsible for withholding and paying trust fund taxes willfully fails to collect or pay these taxes. Responsible individuals can include:

  • An officer, member, corporate director or shareholder
  • A person with control over funds
  • Payroll Service Providers

This is not an exhaustive list. Joint and several liability will apply when multiple individuals were responsible for making these payments. How does this work? Assume two people are liable and one person does not pay, the IRS can seek the full amount from the other.

Fighting a TFRP assessment

One argument may be that the failure was not willful. Whoever was supposed to pay the taxes may not have intentionally disregarded the law. But this can be a challenge, because generally anyone in the position to handle payroll should have been aware of employment taxes requirements.

Another case discussed by Forbes earlier this year, challenged the notice requirements. The taxpayer did not receive written notice of the penalty in the mail, which is a prerequisite to penalty assessment. Usually the IRS sends out Letter 1153 along with a form that lists the trust fund recovery penalty balance and a rights advisory.

In this unusual case, a review of the IRS file turned up an "undated, unsigned and incomplete Letter 1153." Because of this error, the court found the trust fund penalty assessment was invalid.

You have the right to appeal a TFRP, but the amount of time is limited. When you receive any IRS correspondence related to employment taxes, you need to immediately speak with one of our knowledgeable tax attorneys at Robert J. Fedor, Esq., LLC. After a detailed review of your unique situation, we can advise you on your available options and help to minimize the consequences.

Keywords: Trust Fund Recovery Penalty, 100% penalty, payroll taxes, tax fraud