Employers are generally required to withhold employment taxes from employee wages. The employer then remits these withheld employment taxes to the IRS. These are referred to as trust fund taxes, as they are held in trust pending payment to the IRS.
Employers are also required to pay employment taxes for employees based on the wages paid to employees. These employer-paid employment taxes are also remitted to the IRS.
How does the IRS apply partial payments when a trust fund penalty has been assessed? Can the IRS apply payments to the trust fund portion of the employment taxes or must it apply the payment to the non-trust fund penalty portions? The IRS addresses this in CCM 200720015.
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The Trust Fund Penalty
Trust fund taxes that are not remitted to the IRS can be subject to a trust fund penalty. This penalty is 100% of the employee withheld taxes.
The trust fund penalty is a penalty that can be imposed by the IRS on individuals who are responsible for collecting, accounting for, or paying over these trust fund taxes, but who willfully fail to do so. The penalty is equal to 100% of the amount of the unpaid trust fund taxes.
The trust fund penalty can be assessed not only against the business itself but also against individuals who have the authority to direct the payment of the trust fund taxes. This means that if you’re a business owner or a manager who has control over the finances of the business and you fail to pay the required trust fund taxes, you could be held personally liable for the trust fund penalty.
The trust fund penalty is a serious penalty. It can have significant financial consequences for individuals who are responsible for paying trust fund taxes but fail to do so.
How the IRS Applies Payments
This brings us back to the question at hand. How does the IRS apply payments if both trust fund and non-trust fund taxes are owed?
As noted in CCM 200720015, the general rule is that the IRS will follow the taxpayer’s instructions with the payment if the taxpayer specifically designates how the payment is to be applied. This is also set out in Revenue Procedure 2002-26.
In cases where the payment is not voluntary (i.e., it occurs via an IRS wage levy) or the taxpayer fails to designate how the IRS is to apply the payment, the IRS will apply the payment “in the order of priority that the Service determines will serve its best interest.”
When an individual pays their federal income taxes, the IRS will generally apply the payment to the tax period and tax owed that has the shortest IRS tax collection statute, also known as the CSED or collection statute expiration date.
The IRS has a limited time frame, known as the collection statute expiration date, to collect taxes owed by a taxpayer. This time frame typically starts from the date the tax return is filed, and it generally lasts for ten years. Once the CSED expires, the IRS is legally barred from collecting any remaining tax debt.
Therefore, when an individual makes a tax payment that is less than the total amount owed, the IRS will allocate the payment towards the oldest tax debt first, which has the shortest time remaining before the CSED expires. By doing so, the IRS can ensure that they collect as much of the outstanding tax debt as possible before the CSED expires, and they can no longer legally collect the debt.
Where trust fund recovery penalties are involved, the IRS will generally apply the payments “first to the non-trust fund portion of the tax, then to assessed lien fees and collection costs, then assessed penalties, then assessed interest, then accrued penalties and accrued interest, and then finally to the trust fund portion of the tax.”
The Strategy for Paying Trust Fund Taxes
When it comes to paying trust fund taxes, it’s important to have a strategy in place to ensure that you’re meeting your legal obligations and minimizing any potential penalties.
One strategy for paying trust fund taxes is to prioritize the payment of the most recent tax periods first. This is because the trust fund recovery penalty is imposed retroactively on the amount of tax that is outstanding at the time the penalty is assessed. If the penalty is not assessed before the taxpayer pays off the older tax periods, then the IRS will have lost the penalty amounts and interest that would have accrued on the prior tax years.
By paying off the most recent tax periods first, you can reduce the amount of outstanding tax liability that is subject to the trust fund recovery penalty. This can also help to reduce the overall amount of interest and penalties that accrue over time.
The Takeaway
Employers are responsible for withholding and paying employment taxes to the IRS, including trust fund taxes, which are held in trust pending payment to the IRS. Failure to pay trust fund taxes can result in a 100% penalty imposed by the IRS, which can be assessed against individuals who have the authority to direct payment of the taxes. When making partial payments, the IRS generally follows taxpayer instructions on how to allocate payments, but if there are no instructions, the IRS will apply payments in the order that best serves its interest. It’s important to have a strategy in place for paying trust fund taxes to ensure compliance and minimize penalties. Prioritizing payment of the most recent tax periods can help reduce the amount of outstanding tax liability subject to the trust fund recovery penalty.
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