Many small business owners may get behind on employment taxes or payroll taxes and think they will be able to cover whatever their balance is in the coming quarter, or by the end of the year. However, before that time comes they get a letter saying that not only is there an additional $10,000.00 in penalties (not to mention accrued interest) on what was supposed to be a manageable balance, but that the entire amount (the assessed balance, the penalties, and interest) are now personally assessed against the business owner. The IRS now has free reign to levy the business owner’s personal and business bank accounts, seize property, and effectively bring their business and personal life to a screeching halt. All because of a rule called Trust Fund Recovery Penalty.
Trust fund recovery penalties are designed as a tool to encourage businesses who withhold taxes from employee’s paychecks to turn that money over and deposit it to the IRS in a quick, efficient, and regular manner. The name comes from the fact that the business owner is actually holding the employee’s tax payments in trust prior to depositing them with the IRS. The rule applies to any business or small business operator who has employees and withholds any taxes from their employees’ checks. Any and all taxes withheld are potentially subject to trust fund recovery penalties against the employer or responsible party. That means payroll taxes, FICA, medicare taxes, social security taxes, and any other federal taxes that come directly out of employee paychecks are potentially subject to trust fund recovery penalties.Trust fund recovery penalties may be assessed against any person who is responsible for collecting or paying withheld income and employment taxes, or for paying collected excise taxes, and willfully fails to collect or pay them. In the context of a small business, 99% of the time this means that the owner of the business will be the individual who is on the hook personally for the non-deposited funds. However, a responsible person is a person or group of people who has the duty to perform and the power to direct the collecting, accounting, and paying of trust fund taxes. This means that an employee who’s responsible for payroll or accounting can be held personally liable, as well as corporate officers, designated agents, or even third parties such as payroll companies. The bottom line is that when it comes to collecting taxes from businesses, the IRS has given themselves every advantage.
The trust fund recovery penalty is simple to calculate. It is almost like a mirror, the amount of the penalty is equal to the unpaid balance of the trust fund tax. The penalty is computed based on the unpaid income taxes withheld, plus the employee’s portion of the withheld FICA taxes. For collected taxes, the penalty is based on the unpaid amount of collected excise taxes.
Understanding what trust fund recovery penalties are and how they work is critical knowledge for any small business owner. Ideally, an organized system is put into place that safely and securely deposits all of the withheld taxes with the IRS in a timely and efficient manner. But many small businesses for one reason or another do end up in a trust fund recovery situation, and when that happens, as we now know, it is also a personal matter for those responsible, usually the business owner themselves.
The last piece of the trust fund recovery puzzle is then understanding what resolution options are available if and when the trust fund recovery penalty is assessed. To illustrate the various resolution options that might be available to a small business owner in the context of trust fund recovery penalty collection, let’s refer to our old friend Joe.
Joe owns a sports bar. Back in the day, before iphones, facebook, and even the internet, Joe’s sports bar was the place to be to watch the game and responsibly enjoy a drink and some good food with your friends. The bar was successful and Joe never really had to worry about implementing any type of organized accounting system. He had an accountant who would take all his receipts to once each year who would file Joe’s bar’s returns and tell Joe how much he had to make the check out to the IRS for. Because the business was a success, Joe was able to cut the check every year and not worry about it until tax time next year. But now it’s the present day, and there are iphones, and facebook, and sports bars on every corner. Joe’s folksy old sports bar is no longer the local hang out, but he has somehow managed to keep the doors open for business. Joe’s accountant retired a while back and Joe has been using quickbooks to file his quarterly payroll returns, but in order to keep the business alive and pay his employees he hasn’t actually deposited payroll taxes in years. One day Joe receives an LT 11 notice of intent to levy letter from the IRS posted on the front door of his bar saying the bar owes 5 years worth of 941 payroll tax balances totalling $50,000.00, and on top of that, he personally is being assessed $50,000.00 in trust fund recovery penalties as the responsible party. The IRS is planning to levy both his business and personal bank account. The IRS also sends Form 4180 requesting a TFRP interview with Joe. Note that these interviews aren’t just restricted to business owners. The IRS can hold many people involved in the business’s finances liable for these penalties.
First things first, to avoid this situation completely, Joe could have had a process in place way back in the day to make quarterly tax deposits instead of just winging it and signing a check once a year. Now resolving this mess is going to require Joe to make some very difficult decisions. If Joe thinks that the bar’s best days are behind it and is ready to close the doors, the closed business entity, and most likely he himself will be eligible to explore an offer in compromise, a partial pay installment agreement, or possible a hard based plan that would put the balances on the shelf until their collection statute of limitation dates hit.But maybe business turns around suddenly and patrons are banging down the doors at the bar and Joe wants to keep the place open. A more detailed analysis will need to take place that would allow Joe to slowly pay back the IRS while also remaining compliant moving forward.
The example above is similar to a number of trust fund recovery penalty cases that we have handled here at The W Tax Group. No matter what the situation, we are there to work with our small business clients to give them all the facts they need to navigate the tricky situation of trust fund recovery penalties and achieve their specific goals. If you find yourself in Joe’s situation or would like to avoid it altogether, give us a call for a free tax evaluation.
