Trust Fund Recovery Penalty Disputes
Once employment taxes are assessed, the IRS may assess a trust fund recovery penalty (“TFRP”) against the business owners and operators.
This penalty is set out in Section 6672.
Section 6672 provides that any person required to collect, account for, and pay over taxes who willfully fails to perform any of these activities can be assessed a TFRP.
The TFRP relates to amounts withheld from employee paychecks. Employers are generally required to withhold Federal income taxes and the employee’s share of FICA taxes from an employee’s wages. These funds are often referred to as “trust fund” taxes. The reference is to the fact that the employer holds the funds in trust from the employee pending payment to the IRS.
Employers are required to remit trust fund taxes to the government and they are fully liable if the taxes are not timely remitted. Moreover, the employer and the “responsible persons” are jointly and severally liable for a 100% TFRP if the taxes are not timely remitted.
This TFRP makes the business payroll tax liability a personal tax liability for the responsible person who acted willfully. This is why this penalty is needed–i.e., a business owner generally is not liable for payroll taxes incurred by a business entity. Absent this trust fund penalty the IRS could not collect from the business owner personally for unpaid employment taxes.
What is Willful Conduct?
Whether conduct rises to the “willful” standard requires a factual analysis. This analysis asks:
- Whether the responsible person had knowledge of a pattern of noncompliance as delinquencies accrued;
- Whether the responsible person received prior IRS notices that returns were not filed, or were inaccurate, or that employment taxes had not been paid;
- Actions taken by the responsible person to ensure its Federal employment tax obligations have been met after becoming aware of the tax delinquencies; and
- Whether fraud or deception was used to conceal the nonpayment of tax from the responsible person.
Absent willful conduct, there can be no TFRP.
Who is a Responsible Person?
A “responsible person” is anyone who: a) has the duty to perform or b) the power to direct c) the act of collecting, accounting for, or paying over trust fund taxes. What does this actually mean?
Generally “responsible persons” include anyone who has the ability to make financial decisions for the business, including owners, managers, and even lesser employees, such as bookkeepers.
This often includes the CEO and CFO for the business. The IRS will often try to impose the penalty on as many people as it can. It is common for the IRS to assess the penalty against anyone who signed checks for the business. The IRS has even tried to impose a penalty on the stay-at-home spouse of a business owner.
The IRS can also try to impose penalties on those who have a Form 2848, Power of Attorney, for the business.
The law generally allows the penalty to be assessed against anyone who could have caused the business to pay the taxes. The analysis considers whether the alleged responsible person allowed other business expenses to be paid before the taxes are paid. This includes paying anyone, even if the payment makes it more likely that the business will survive and be able to pay more taxes to the IRS. Even if the responsible person uses their own funds by making a loan to the business to pay non-payroll taxes, the loan proceeds have to be used by the business to pay the payroll taxes.
Worse yet, there may not be a reasonable cause defense to the TFRP. The courts have differed in applying this defense.
The IRS revenue officer will conduct interviews to determine who can be a responsible person. The revenue officer will complete Form 4180 in an in-person interview with each potentially responsible person.
Taxpayers have to be very careful about this form, as the form can be admissible evidence that the taxpayer is “responsible” and non-payment was “willful.”
If there is any indication that the matter could result in criminal liability (which is discussed below), it may be necessary for the taxpayer to require the IRS to issue a summons before agreeing to a trust fund penalty interview. And even then, the taxpayer may assert his or her right not to respond under the Fifth Amendment. This is rare, but critical in cases that could result in criminal liability.
The IRS Often Fails to Send the Required Notice
But just because the IRS says a TFRP is due, does not mean that one is due. The IRS often fails to properly assess or record the TFRP on its books.
For example, it often fails to provide the taxpayer with the required notice before assessing the TFRP. There have been several court cases where the penalty was reversed for this very reason. The IRS has even refused to correct these errors when the taxpayers have notified the IRS of the errors. But that does not mean that you can simply avoid getting your mail with the hope that the notice isn’t received.
Is the Depletion of Social Security a Defense to Penalties?
One of the questions we often get is about how FICA funds Social Security and Social Security is slated to be depleted before it pays out to many Americans. This begs the question as to how the government can assess this tax and then levy a trust fund penalty for those who are likely not getting their Social Security payout anyway. One can easily see the inequity here–particularly for younger taxpayers who everyone agrees are not likely to see any payout from Social Security. Unfortunately, as of now, this issue has not gotten widespread attention. As of now, this inequity is not a defense to the tax or penalties. This issue is likely to be more visible as we get closer to the date that Social Security funds run out. It isn’t likely that the government will waive past payroll taxes or trust fund penalties even given this inequity.
Dealing with TFRPs
There are a number of strategies for dealing with TFRPs. One is to simply wait for other responsible parties to pay the tax. This can work if the penalty is assessed against multiple parties and one of the parties is likely to pay or have assets that the IRS can easily seize or levy.
If you are going to pay the penalty, you may find that it makes sense to pay the oldest trust fund tax first. That can curtail the running of non-payment penalties and interest on the TFRP. If done correctly, you may also find that you can deduct the back taxes on your current year’s tax return.
But there are some things you cannot do. For example, you cannot challenge the amount of the penalty in some cases. Note that challenging the amount of the penalty may be different than challenging whether you are a responsible person. In some circumstances, challenging the amount of the penalty may preclude tax court review.
And recall as noted above, making a restricted loan to the business using personal funds does not work. This can result in liability for the business owner.
Help With Your Payroll Tax Problem
An experienced tax attorney can help you understand your tax obligations for your employees and help resolve your payroll tax problems. An experienced tax attorney can also help you review and structure your employee and independent contractor relationships so that your business does not run into these types of payroll tax problems.
Please call us at payroll tax attorneys.or schedule an appointment with our