Payroll taxes behind: the trust fund recovery penalty explained

Why are unpaid payroll taxes treated differently?

The income tax withheld from paychecks and the employee share of Social Security and Medicare are called trust fund taxes, because the employer holds them in trust for the government. When they are not deposited, the IRS can assess that amount personally against the people responsible, through the trust fund recovery penalty, even when the business is a corporation or an LLC. The employer's own share of Social Security and Medicare is not trust fund, and the penalty does not reach it, but the trust fund portion is usually most of a 941 balance.

Payroll tax is not the only business tax that can reach an owner personally. Sole proprietors and general partners are personally liable for the taxes of their business, owners of S corporations and partnerships pay tax on the business's income on their own returns, and states have their own rules. Florida, for example, can assess a penalty of twice the unpaid tax against a person who willfully fails to collect or send in sales tax, including an officer or director who controls those payments. What sets payroll tax apart is that the law gives the IRS a direct route to the individuals responsible, whatever the form of the business.

Who the IRS can hold responsible

The trust fund recovery penalty equals the unpaid trust fund portion and can be assessed against any responsible person who acted willfully. Responsible means having the duty and the power to decide which bills get paid: owners, officers, partners, and sometimes an employee, such as a bookkeeper or office manager, who actually made those decisions. Ownership alone, or signing checks as directed by someone else, is not enough. Willful means knowing, or being in a position where you should have known, that the taxes were unpaid and paying other creditors, including payroll itself, instead; it also covers intentional disregard of the payment requirement or plain indifference to it. Bad intent is not required. Several people can be assessed for the same amount, but the IRS collects it only once.

How the assessment happens

A revenue officer investigates, usually with an interview on Form 4180 about who did what in the business. If the officer concludes you are responsible, you receive Letter 1153 proposing the assessment, with 60 days to appeal, or 75 days if the letter is addressed outside the United States. After that, the penalty is assessed on your personal account and collected from your personal assets and income like any other tax.

First rule: stop the bleeding

Before any negotiation, the IRS looks at whether current deposits are being made in full and on time. A business that is still falling behind cannot get an agreement for the old balance. So the first move is to make every deposit from today forward, even if it means cutting elsewhere. Payroll taxes should never be the bill that gets paid last, because the unpaid trust fund portion can follow the responsible people home.

Options for the back balance

• A Simple Payment Plan for business trust fund taxes, the new name of the in-business trust fund express agreement, generally available without a financial statement when the balance is $25,000 or less. The threshold alone does not establish eligibility: the plan has to pay the balance in full by the collection deadline, filing and payment compliance is checked, and a request made together with a request to release a levy calls for additional analysis under the current Internal Revenue Manual.
• A regular installment agreement with financial statements for larger balances.
• Designating a voluntary payment to the trust fund portion, in writing and at the time of the payment, which reduces the amount that can be assessed personally. Payments under an installment agreement cannot be designated.
• An offer in compromise in limited situations, with the business current on deposits and the trust fund portion paid or the personal penalty determination made.
• For a business that has closed, resolving the personal assessment directly.

Every situation is different and results depend on the facts of each case. This guide is general information, not advice on your file. The complimentary 15-minute introductory call is where your facts come in.