If you own or manage a business with employees, there’s a harsh tax penalty that you could be at risk for paying personally. The Trust Fund Recovery Penalty (TFRP) is a penalty assessed for unpaid trust fund taxes. These taxes include Social Security, withholdings, and employment taxes that are withheld by a business from its employees’ wages.
The TFRP is dangerous because it applies to a broad range of actions and a wide range of people involved in a business. The penalty can apply to any unpaid trust funds taxes that cannot be collected from the business immediately.
What actions are penalized?
The TFRP applies to any willful failure to collect, or truthfully account for, and pay over taxes required to be withheld from employees’ wages.
Why is it so harsh?
Taxes are considered the government’s property. The IRS explains that Social Security and income taxes “are called trust fund taxes because you hold the employee’s money in trust until you make a federal tax deposit in that amount.”
It is also sometimes called the “100% penalty” because the person found liable is personally penalized 100% of the taxes due. The amounts the IRS seeks are usually substantial and the IRS is aggressive in enforcing the penalty.
Who’s at risk?
The penalty can be imposed on anyone “responsible” for willfully failing to collect and pay these taxes. This has been broadly defined to include a corporation’s officers, directors and shareholders, a partnership’s partners, and any employee with related duties. In some circumstances, voluntary board members of tax-exempt organizations have been subject to this penalty. In other cases, responsibility has been extended to professional advisors and family members close to the business. Anyone with authority, that knows that these funds are not being paid or are outstanding, can be held liable.
According to the IRS, responsibility is a matter of status, duty, and authority. There’s often more than one responsible person in a business, but each is at risk for the entire penalty. You may not be directly involved with the payroll tax withholding process in your business. But if you learn of a failure to pay withheld taxes and have the power to pay them (are authorized to write checks), you become a responsible person. Although taxpayers held liable can sue other responsible people for contributions, this action must be taken entirely on their own after the TFRP is paid.
What’s considered willful?
There doesn’t have to be an overt intent to evade taxes. Simply paying bills or obtaining supplies instead of paying over-withheld taxes is willful behavior. And just because you delegate responsibilities to someone else doesn’t necessarily mean you’re off the hook. Failing to do the job yourself can be treated as willful. Any use of available funds to pay other creditors, rather than the outstanding taxes that the individual is aware of or shows in the difference can be considered willfulness.
Recent cases that illustrate the risks
- A U.S. Appeals Court held a hospital administrator liable for the TFRP. The administrator was responsible for payroll, as well as signing and reviewing checks. She also knew that the financially troubled hospital wasn’t paying withheld taxes to the IRS. Instead of prioritizing paying taxes, she paid vendors’ and employees’ wages. (Cashaw, CA 5, 5/31/23)
- A corporation owner’s daughter/corporate officer was assessed a $680,472 TFRP for unpaid payroll taxes. She argued that she wasn’t a responsible party. She owned no stock and couldn’t hire and fire employees. But she did have the power to write checks and pay vendors and was aware of the unpaid taxes. A U.S. Appeals Court found the “great weight of evidence” indicated she was a responsible party and the TFRP was upheld. (Scott, CA 11, 10/31/22)
Under no circumstances should you “borrow” from withheld amounts. All funds withheld should always be paid over to the government on time. You can avoid any penalties by making sure that all taxes are paid to the IRS when required and have been properly collected and accounted for within the companies’ records.