Trust Fund Recovery Penalty
What is the Trust Fund Recovery Penalty?
The Trust Fund Recovery Penalty (TFRP) allows the IRS or a state tax board to hold individuals personally liable for certain taxes that were not paid to the government on time. In the eyes of the IRS, this can be comparable to theft, and the penalties can be severe. The most common types of taxes involved in a TFRP are employment taxes and sales taxes.
During an investigation, the taxing authority must establish that trust fund taxes were willfully unpaid, and also determine who is responsible for the error. The individuals deemed responsible can be on the hook for the full amount of unpaid tax, plus interest, but there are ways to fight the TFRP or mitigate the situation.
What are trust fund taxes?
You may be thinking of the trust funds held by wealthy families, but in this case, trust fund taxes refer to the taxes that businesses must withhold from employees or customers and remit to the state.
Businesses are responsible for withholding certain taxes from employees’ paychecks, including income tax, Social Security, Medicare, and unemployment tax. As a business owner, you hold these taxes “in trust” for your employees, then hand them over to the IRS and/or state tax board later.
When you sell items that are subject to sales taxes, you must collect sales tax from your customers. You hold these funds in trust until you remit sales and use tax to the state tax board.
Note: Sales and use taxes are under state jurisdiction, so any penalties for failure to pay these taxes on time would be assessed at the state level.
How much is the Trust Fund Recovery Penalty?
The IRS Trust Fund Recovery Penalty is equal to the amount of trust fund taxes that were withheld and not paid. Interest will also accrue starting on the date the tax was due.
Although the TFRP only applies to taxes that were actually held in trust (i.e. the payroll taxes withheld from employees’ paychecks or the sales taxes collected from customers), other penalties can apply if these taxes were never withheld/collected to begin with.
Who is responsible for unpaid payroll taxes or unpaid sales tax?
Anyone at the company who is found to be both responsible and willful can receive the Trust Fund Recovery Penalty. Both requirements must be met in order for the TFRP to be assessed.
Any individual who is responsible for collecting and paying trust fund taxes could be eligible for a Trust Fund Recovery Penalty assessment. In a small company, the owner of the company is typically considered responsible by default. However, it doesn’t stop there. Who’s running payroll? Who manages the books? Who signs the company’s checks?
Employees, bookkeepers, accountants, and third-party administrators are all fair game when it comes to the TFRP. A key factor of the responsibility test is whether the individual has the power to decide which bills are paid.
In addition to being responsible, an individual must be deemed willful in their nonpayment before they can receive an IRS Trust Fund Recovery Penalty. Choosing to pay other bills while failing to remit trust fund taxes, for example, may be considered willful behavior. Reckless disregard for the duty of collecting and paying these trust fund taxes can also establish willfulness.
It is not necessary to have bad intent. For example, the owner of a company may choose to cover payroll rather than taxes, thinking that the taxes will be paid at a later time. However noble the intention is, paying other creditors over the IRS or state taxing authority may be seen as willful conduct.
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