Did you know that in certain cases the IRS can hold an individual personally responsible for a business’s outstanding IRS liabilities? The IRS can assess a “Trust Fund Recovery Penalty” (TFRP) against individuals associated with the business who meet specific criteria. When a business or employer fails to remit to the IRS the income taxes, social security taxes, and Medicare taxes withheld from employee paychecks, the IRS can seek to collect a portion of these taxes (referred to as “trust fund taxes”) from certain individuals. If a taxpayer is held personally responsible for non-remittance of these taxes, the IRS could pursue the individual’s personal assets to collect, including using liens and levies. Furthermore, a TFRP is nondischargeable in the bankruptcy of the responsible person.
When does the Trust Fund Recovery apply?
On the Federal level, there are three parts or types of payroll or employment taxes withheld from the employee and reported on a Form 941, which is filed quarterly to the IRS. These 3 taxes are: income taxes withheld from employee pay; FICA taxes (Social Security and Medicare taxes) withheld from employees; and FICA taxes payable by the employer. With respect to Federal withholding for income taxes and Employee FICA, if employers fail to make tax deposits and payments on time they are subject to a Trust Fund Recovery Penalty.
What is the test for determining who may be assessed the Trust Fund Recovery Penalty?
The TRFP may be assessed against any person who is responsible for collecting or paying withheld income and employment taxes and willfully fails to collect or pay them. The key to the federal test is whether an individual exercised independent judgment with respect to the financial affairs of the business.
An act is willful if it is voluntary, deliberate, and intentional. To show willfulness, the government generally must demonstrate that a responsible person was aware or should have been aware of the outstanding taxes and either intentionally disregarded the law or was plainly indifferent to its requirements. A responsible person’s failure to investigate or correct mismanagement after being notified that withholding taxes have not been paid satisfies the requirement for willfulness. Using available funds to pay other creditors when the business is unable to pay the employment taxes is also an indication of willfulness. If the employee lacked the authority to decide which creditors would or would not be paid, then they would not be liable.
What factors are taken into consideration when determining who may be a responsible person?
There are several relevant factors including:
- Ownership of stock
- Authority to sign tax returns
- Authority to sign checks
- Authority over business decisions
- Control over the finances of the business
- Authority over employees
- Extent of the officer’s knowledge of the business’ affairs
- Benefits received from the corporate profits
There is no requirement to fulfill a specific number of these factors in order to be designated a responsible person.
What types of employees are commonly found liable for the TFRP?
A responsible person may include (but is not limited) to the following individuals:
- An officer or an employee of a corporation
- A member or employee of a partnership
- A corporate director or shareholder
- Another person with authority and control over funds to direct their disbursement
- Another corporation or third-party payer
- Payroll service providers
What appeal rights do taxpayers have?
Taxpayers have the right to appeal a proposed TFRP prior to assessment. If a taxpayer chooses not to appeal the proposed assessment, he/she may still file a claim for a refund with the IRS after the assessment has been made.
A written protest of the assertion and assessment of the TFRP is made to the Revenue Officer, who will prepare a file, including his/her rebuttal to the protest, and submit it to the Special Procedures function to the Office of Appeals. While the appeal is pending, no interest will accrue on the account.
The Office of Appeals will then consider the appeal. As part of the appeal process. the taxpayer has the right to a personal conference with an Appeals Officer where he/she can be represented by an accountant or attorney. The taxpayer is also entitled to present evidence and witnesses on his/her behalf at the conference.
If the Appeals Officer is convinced that the taxpayer is not a responsible person, he/she will recommend nonassertion of the penalty. However, if the Officer is not convinced, an assessment will be made by the service without the taxpayer being granted the right to go to Tax Court.
During the appeals process, the Appeals Officers will look at the litigation risks of a case and may base a settlement on those risks.
If you face a proposed Trust Fund Recovery Penalty or have been assessed the penalty, you can seek to have the penalties reduced or eliminated. Speak to a qualified attorney about your situation.