Trust Fund Recovery

What is the IRS Trust Fund Recovery Penalty?

The trust fund recovery penalty is a penalty you have to pay if you withhold income and payroll taxes from your employees’ paychecks, but don’t send that money to the IRS. It’s one of the IRS’s largest and most serious penalties and one that you could be personally liable for even if it was your business that had to collect and remit those taxes. So it’s no surprise that if you receive an IRS notice about the trust fund recovery penalty, it’s a serious matter you need to address promptly.

Key Takeaways

• Trust fund taxes are taxes employers withhold from their employees’ pay. 
• Trust fund taxes include the employees’ Social Security, Medicare, and income tax.
• Employer’s matching Social Security and Medicare payments are not trust fund taxes.
• The trust fund recovery penalty is 100% of the unpaid tax.
• The IRS can assess this penalty against liable individuals.
• If the IRS thinks you may be liable, they will send you a letter to schedule an interview.
• The IRS is very strict about this penalty and waivers are very rare.

The tax attorneys at The W Tax Group have extensive experience dealing with trust fund recovery penalties, and we can help you deal with the IRS.

What Are Trust Fund Taxes?

Trust fund taxes include employment tax, income tax withheld from your employees, and excise taxes you have collected. These taxes are called trust fund taxes because you collect them from another person, hold them in trust, and send them to the IRS. If you don’t meet this duty, you could be liable for the trust fund recovery penalty under IRS Code 6672.

Here’s an example. Say you pay your employee $1500. You withhold $93 for Social Security contributions, $21.75 for Medicare premiums, and $150 for income tax. This $264.75 is the trust fund tax. As an employer, you also have to match the Social Security and Medicare tax you withheld from your employee. So, the total amount you’re required to send to the IRS for your employee’s $1,500 paycheck is therefore $379.50 (this is the $264.75 trust fund tax plus $114.75 for your portion of the Social Security contributions and Medicare premiums).

If you don’t pay, you may incur the Trust Fund Recovery Penalty on the withheld amount. However, the matching amounts are not considered trust fund taxes, and they won’t be subject to the trust fund recovery penalty. That said, you may still incur penalties (like the 941 late payment penalty) and interest for not paying these taxes.

How Much Is the Trust Fund Recovery Penalty?

The trust fund recovery penalty is equal to the unpaid trust fund taxes. To return to the above example, if you don’t pay the $264.75 in trust fund taxes, the TFR penalty will be $264.75.

This all comes from just one paycheck from a single employee. If you have dozens of employees and fail to remit the trust fund taxes over a period of months or years, the TFRP could be a staggering amount. As if that’s not bad enough, the IRS doesn’t just go after businesses for this penalty. It goes after anyone who may be responsible, and the agency will seize personal assets to cover the bill.

Who Has to Pay the Trust Fund Recovery Penalty?

The IRS can hold a lot of different people responsible for the trust fund recovery penalty. Essentially, anyone who was responsible for paying the trust fund tax and failed to pay it can be held responsible. That includes the following:

• A corporate officer, director, employee, or shareholder
• A partnership member or employee
• Nonprofit board of trustee members
• Third-party payer
• Responsible parties at a payroll service provider or professional employer organization

The IRS will examine various factors in deciding if you or someone else is a “responsible person” for TFRP purposes. Some of these factors include the person’s:

• Job duties and job title
• Power to hire and fire employees
• Signature authority over the business’s financial accounts

One thing to note about finding the person (or persons) responsible for the TFRP is that the IRS will primarily look for those who had control over the business’ payments. This doesn’t require them to have complete, absolute, or final control over how the business pays its bill. But if an individual has substantial influence in how company funds are spent, the IRS will likely conclude they’re a responsible party.

Assuming you’re a responsible party, you must also have acted willfully in not paying the taxes. For instance, if you handle the finances for a company and you decide to pay your electric bill instead of your trust fund taxes, you’re acting willfully. However, if your job is just to write checks as directed by your boss, you’re not likely to be responsible. In other words, if you have ministerial duties, the IRS probably won’t find you to be a responsible person within the TFRP context.

It’s important to note that you can act willfully for TFRP purposes even if you had the best of intentions or otherwise acted in good faith. For example, if you honestly believed you were legally required to pay other creditors before the IRS, you still acted willfully. You may also be found to have acted willfully if you knew your business wasn’t paying its trust fund taxes and you simply relied on someone telling you the trust fund taxes were now getting paid without verifying their statements.

What to Expect If You Have Unpaid Trust Fund Taxes

If the IRS finds out that a business isn’t paying its trust fund taxes, a revenue officer will start to look for the responsible party. They will request info from the company to figure out who is responsible for paying these taxes. This may include bank statements, canceled checks, information about who has access to online accounts, partnership agreements, and articles of incorporation. There’s also the chance they interview you or anyone else they feel could be a responsible party (more on this below).

IRS Notifications of Trust Fund Recovery Penalties

Once the agency identifies some potentially responsible parties, it will send out Letter 1153 (Trust Fund Recovery Penalty Proposed). You have 10 days to informally protest the assessment, and you have 60 days from the date on the letter to file an appeal with the IRS Office of Appeals.

The notice will also include Form 2751. If you sign this form, you are admitting responsibility and agreeing to the trust fund recovery penalty. Then, the IRS will send you Letter 1155(DO), Notice of Agreed Trust Fund Recovery Penalty.

Prior to signing this form, you may want to consult with a tax attorney. They can help you respond to the IRS and ensure you get the best outcome possible for your situation.

What Is the Trust Fund Recovery Interview?

The IRS can summon anyone it believes may be responsible for unpaid trust fund taxes to an interview. This is called a 4180 interview because the IRS agent asks questions from Form 4180. The questions help the IRS determine if you were responsible for paying the tax.

You can avoid a 4180 interview by doing one of the following:

• Paying the trust fund taxes and penalty
• Admitting responsibility by signing Form 2751

If you believe that you’re not responsible for the trust fund taxes, you may want to consult with a tax professional. They can help you through this process. They can also help if you signed Form 2751 accidentally.

How Can You Avoid Paying an IRS Trust Fund Recovery Penalty?

Prevention is key here. You want to have a tax professional review your payroll and tax filing processes and make sure everything is being done properly. Then after you confirm everything is above board, you periodically review your tax and payroll records to ensure the trust fund taxes are being collected and paid as required by law. 

Conducting this review quarterly is a good recommendation, but the exact frequency needed will also depend on what sort of internal controls and checks you have in place. If you have multiple employees handling payroll and taxes (and they can check each other’s work), but then an outside accountant reviews their work every quarter when preparing quarterly tax filings, then an annual trust fund tax review might be sufficient.

What If You Can’t Afford to Pay the Trust Fund Recovery Penalty?

If you cannot afford to pay the trust fund recovery penalty, you may be able to set up an installment agreement to pay the tax and penalty in monthly payments. If you cannot pay anything, you can apply for currently not collectible (CNC) status. This requires a full financial disclosure, and the IRS will review your situation every two years to see if anything has changed.

Unfortunately, it’s difficult to get the IRS to waive the trust fund recovery penalty. Even if you were to incur the penalty because of severe emotional, physical, and financial hardship, the IRS is unlikely to take sympathy. This was made clear in United States v. Williams, where the IRS imposed the trust fund recovery penalty on a dentist who incurred these penalties when his dental practice fell on hard times. 

During these hard times, the dentist lost his son, sister, and brother-in-law and underwent back and heart surgeries. As if that weren’t bad enough, he also suffered from opioid use disorder and had to care for his ailing wife. Despite all this, the IRS still found the dentist personally liable for the trust fund recovery penalties.

The bottom line is that being in a difficult situation probably won’t be enough to avoid the TFRP with a waiver or abatement. However, you may be able to use your circumstances to apply for and obtain CNC status or get the IRS to accept an offer in compromise.

Get Help with the Trust Fund Recovery Penalty

Negotiating with the IRS on your own regarding the trust fund recovery penalty is a daunting task. There’s also the fact that you could be personally liable for this penalty. As a result, hiring a tax attorney for help could be your best option. The team at The W Tax Group can help you negotiate an arrangement with the IRS and protect your personal assets from additional collection actions. Get help now by contacting us today.