When you pay your employees, you don’t pay them all the money they earned. The federal income tax and employees’ share of social security and Medicare taxes that you withhold from your employees’ paychecks are part of their wages that you pay to the U.S. Treasury instead of to your employees. Your employees “trust” that you will pay the withheld taxes to the U.S. Treasury by making federal tax deposits. This is the reason that these withheld taxes are called “trust fund taxes.”
If federal income, social security, or Medicare taxes that must be withheld aren’t either 1) withheld or 2) deposited or paid to the U.S. Treasury, the government can charge a very serious penalty called the Trust Fund Recovery Penalty (TFRP). If you are looking at an IRS Account Transcript for your SSN (or a tax lien), you may see notations for Civil Penalty, CIV-PEN, or 6672 Penalty. To get a better understanding of trust-fund taxes, you should also understand non-trust fund taxes.
What Are Non-Trust Fund Taxes?
Employers must match their employees’ Social Security and Medicare contributions. Those matching amounts are considered non-trust fund taxes. The IRS typically only holds a business responsible for non-trust fund taxes if they aren’t paid to the government. It does not hold individuals responsible. However, the exact liability rules depend on your business structure. If the business is “self-employed” or the sole principal of an LLC, a person may be held personally responsible for both trust-fund and non-trust fund taxes.
How Much Is the Trust Fund Recovery Penalty Amount?
The Tax Fund Recovery Penalty is not small. In fact, it is equal to 100% of the amount of taxes that were unpaid. Once again, that includes any income taxes withheld from an employee’s paycheck plus the employee’s Social Security and Medicare contributions. Note that Social Security and Medicare contributions are also referred to as FICA (Federal Insurance Contributions Act) taxes.
To illustrate, let’s say you paid an employee $2,000. You noted on the paycheck stub that you withheld $200 for income tax plus $124 for Social Security and $29 for Medicare. However, you didn’t send any of that money to the IRS. In that case, the unpaid tax bill is $353. You owe that amount plus that amount again as a penalty. That effectively doubles your bill!
Who Can Be Responsible for the TFRP?
If these unpaid taxes can’t be immediately collected from the employer or business, the TFRP may be imposed on all persons who are determined by the IRS to be responsible for collecting, accounting for, or paying over these taxes, and who acted “willfully” in not doing so. That includes owners, CEOs, and directors, but it can also include employees, third party payroll administrators, outside accountants, and bookkeepers.
To establish responsibility, the IRS has to prove two things. First, that the individual in question was responsible for remitting the taxes (i.e. the responsible party). Second, the individual must aware that the taxes were due and purposefully or willfully ignored the law (i.e. willfulness). For example, if you or someone related to your organization took the money set outside for payroll and income taxes and used it to pay another bill, that’s a clear sign of willfulness.
How does the IRS Assess a TFRP?
If the IRS believes that a company hasn’t been paying its trust fund taxes, a Revenue Officer from the IRS starts an assessment to identify the responsible party. As part of that process, the IRS requests multiple documents and lots of information from the company. This documentation includes bank statements and canceled checks, but it also includes details about who has passwords for online accounts and who knows PINs for bank cards. Basically, the IRS wants to see who’s paying the bills, who’s controlling the money, and where the money is going. They will also want to conduct an interview known as a 4180 interview (which is based on IRS-Form-4180).
Once the IRS identifies who was responsible and willful, they will assess the penalty.
What Forms Are Involved in the TFRP?
If the IRS thinks you are responsible, you will receive Letter 1153. This is the notice the IRS sends when the business has refused to pay the payroll taxes, and the IRS has decided to hold an individual personally responsible for the debt. Accompanying this letter is Form 2751.
Signing Form 2751 is an admission that a person is responsible for the unpaid payroll tax. Once the form is signed, it is almost impossible to reverse it. The only way to change the admission is to hire an attorney who can argue that you were coerced into signing. As such, if a person doesn’t agree with the letter, then it is not advised to Form 2751. The notice gives you 60 days to appeal, and to do so, you need to prove that you were not responsible for the unpaid tax debt.
What Is the Statute of Limitations on the TFRP?
If the IRS assesses a penalty, it has up to 10 years to collect it. During that time, if you have not made arrangements to settle/pay the penalties, then you can be subject to “enforced collections” (i.e. the IRS attempting to seize assets, garnish wages, offset refunds, etc.).
However, the IRS only has 3 years to assess the penalty. This clock starts ticking on April 15 after the year the trust fund taxes were due to be filed. For instance, let’s say a company was supposed to pay some trust fund taxes in October 2019. The IRS has three years from April 15, 2020 to assess the penalty. If the IRS doesn’t do anything by April 14, 2023, it can’t do anything after that date.
How Can You Settle the Penalty?
Like other types of tax debt, there are options to pay this penalty. If you don’t have the full payment, you can apply for a payment plan (a.k.a installment agreement). Alternatively, you can try to settle the debt for less than you owe through the offer in compromise program or through a partial payment installment agreement.
The important thing to note is that you should contact the IRS and set up an arrangement before the IRS tries to garnish your wages or seize your assets. It is also important to note that these penalties can not be discharged in bankruptcy.
Need help with your payroll tax problems?
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