Congress created the trust fund recovery penalty (TFRP) as a civil penalty designed to encourage businesses to pay their federal withholding taxes, including income taxes and the employees’ share of FICA, which goes toward Social Security and Medicare, in a timely fashion. Federal withholding taxes may also be referred to as trust fund taxes or 941 liabilities. When an employer pays an employee, it withholds certain taxes and holds them in trust until it pays them to the U.S. Treasury by making a federal tax deposit. Essentially, the TFRP is an alternative way of collecting delinquent payroll taxes when the IRS is unable to fully collect them from the business, corporation, or organization. A person may be subject to the TFRP if the person is responsible to collect and/or pay withheld income and employment taxes, or to pay collected excise taxes, and willfully fails to either collect or pay them. If a responsible person willfully fails to pay the taxes, he or she may be personally liable for the TFRP in the amount of the unpaid taxes, plus interest.
Responsible people for the purposes of the TFRP include the following:
A responsible person is a person who has the duty to collect, account for, or pay over trust fund taxes, or the power to control those activities.
Furthermore, the responsible person must have willfully failed to pay the withheld taxes, in that the person must have or should have been aware of the outstanding taxes, and either intentionally disregarded the law, or was indifferent to the requirements of the law. Willful behavior is intentional, voluntary, and knowing behavior, as contrasted with accidental behavior. The standard for willfulness in the context of the TFRP is less than that standard used in criminal proceedings, because the TFRP is a civil process. A common example of willfulness occurs when a responsible person uses withheld taxes to pay a different bill or operating expense, instead of paying the taxes to the IRS as required.
The TFRP is equivalent to the balance of the unpaid payroll taxes, and is based on the unpaid taxes withheld and the employee’s portion of the withheld FICA taxes. With respect to excise taxes, the penalty is simply the unpaid amount of the collected excise taxes. IRS payroll tax penalties also include interest assessed on the TFRP, so the responsible person ultimately may end up paying an amount in excess of the unpaid taxes.
First, the IRS will determine the identity of any person responsible for the taxes required to be withheld and paid on behalf of employees. This step of the process may involve personal interviews in order to determine the specific duties and responsibilities of persons involved with the tax withholding and payment process for a particular business or organization. There may be more than one responsible person.
Once the IRS has determined the identity of the responsible person or persons, the IRS will send a letter, which is entitled 60-Day Notice of Proposed Assessment, notifying that person that it will assess the TFRP. The letter gives the responsible person 60 days from the date on which the letter was mailed in which to appeal the IRS assessment of the TFRP, and explains the appeal process and rights. Whenever the responsible person files a timely appeal, the TFRP assessment period will extend to 30 days after the date of the appeals decision. If the responsible person fails to respond to the letter altogether, then the IRS will go ahead and assess the TFRP.
After the IRS assesses the TFRP, it sends the responsible person a Notice and Demand for Payment, which is an official IRS notice that demands payment from an individual or business. If the responsible person fails to pay as per the IRS demand, then the IRS can use its collection tools to collect the TFRP, which may include federal tax liens or seizure of assets. The TFRP is normally exempt from bankruptcy discharge, except in the case of Chapter 13 bankruptcy cases that were filed prior to October 17, 2005.
The best advice for a business that wishes to avoid the negative consequences of the TFRP is to avoid it altogether in the first place. By ensuring that withholding taxes are paid in full and on time, you will not face the assessment of the TFRP. If you do find yourself in a situation where you are potentially liable for the TFRP, you should contact an experienced tax lawyer for help. With legal counsel, you may be able to enter into a settlement with the IRS or otherwise compromise the the amount owed.