A refresher on the trust fund recovery penalty for business owners and executives
October 11, 2023
One might assume the term “trust fund recovery penalty” has something to do with estate planning. It’s important for business owners and executives to know better.
In point of fact, the trust fund recovery penalty relates to payroll taxes. The IRS uses it to hold accountable “responsible persons” who willfully withhold income and payroll taxes from employees’ wages and fail to remit those taxes to the federal government.
A matter of trust
The trust fund recovery penalty applies to employees’ share of payroll taxes, including withheld federal income taxes and the employee share of Social Security and Medicare taxes.
These monies are considered trust funds because they’re the property of the federal government, held in trust by the employer. The penalty amount is 100% of the unpaid taxes plus interest — it essentially serves as an alternative tax-collection method.
A responsible person
The trust fund recovery penalty is particularly dangerous because it can ensnare persons who ordinarily are protected against personal liability for business debts. As stated in the tax code, the penalty provides that:
Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.
The IRS and courts take a broad view of who may be a responsible person under this provision. It has been interpreted to include a range of individuals, within or outside the business, who possess significant control or influence over the company’s finances.
Whether someone is a responsible person depends on the facts and circumstances of the case, but factors that may support that conclusion include ownership interest, title, check-signing authority, control over bank accounts or payment of debts, hiring and firing authority, control over payroll, and power to make federal tax deposits.
Thus, responsible persons may include shareholders, partners and members of a limited liability company; officers; other employees; and directors. Responsible “persons” can also be payroll service providers and professional employer organizations, including individuals employed by those entities. Outside advisors may be deemed responsible persons as well.
Important note: If several responsible persons are identified, each may be held liable for the full amount of the penalty assessed.
Willful failure
As noted in the quote above, failure to pay trust fund taxes must be willful to trigger the trust fund recovery penalty. The IRS interprets this term broadly to include not only intentional acts, but also reckless disregard of obvious or known risks that taxes won’t be paid. The courts have described various scenarios that reflect a reckless disregard, including:
• Relying on statements of a person in control of finances, despite circumstances showing that this person was known to be unreliable,
• Failing to investigate or correct mismanagement after receiving notice that taxes weren’t paid, and
• Knowing that the company is in financial trouble but continuing to pay other creditors without making reasonable inquiry into the status of payroll taxes.
Simply put, delegating the handling of payroll taxes to a certain individual or outside provider may not be enough to avoid liability.
Risky circumstances
Few business owners or executives wake up one morning and decide to disregard payroll taxes. However, circumstances can develop that put you at risk. We’d be happy to explain the rules further and help you stay in compliance.
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