Trust Fund Recovery Penalty

IRS Trust Fund Recovery Penalty Help | TFRP Interview | TFRP Appeal

The IRS considers back payroll tax debt as the most serious of all tax debts. The IRS views operating a business while owing back payroll taxes as illegally borrowing money from the government. The IRS can seize assets and force you out of business if you owe back payroll taxes.

The scary thing about payroll taxes is that the IRS can assess a portion of the tax, called the Trust Fund Recovery Penalty, on individuals it believes had authority to collect and pay the tax. This can be an owner manager and even a bookkeeper.

The number one reason we have business clients is because of unpaid payroll taxes. Each scenario basically works similar to this:

Business is slow. You pay the rent and your employees’ wages, but don’t make your federal tax deposits. You believe that things will turn around next month with more work. The busy season is right around the corner and you are sure that you’ll be able to pull out of this slump catch up on your back payroll taxes.

Several months go by. Your sales have gone down. Orders stopped coming in and holiday sales were awful. Your vendors have sued you and your landlord is threatening to evict you. You haven’t been filing your 941 returns or made any federal tax deposits for the last several quarters. You decide to shut down and sell your assets to pay off the creditors you have personally guaranteed.

You feel that you are ready for a fresh start with everyone paid off. But wait. The IRS sends you a notice saying that they intend to hit you personally with a 100% penalty for non-payment of payroll taxes, also know as the dreaded “Trust Fund Recovery Penalty”.

When payroll deposits haven’t been made, the IRS can review a company’s books, interview employees and then hold its owners, managers, bookkeepers and check-signers personally responsible for the unpaid payroll taxes. This penalty applies mostly towards corporations. If you were a sole proprietorship, LLC or partnership, you can be found directly responsible for payroll taxes without the TFRP provision.

How the IRS Determines Who is Responsible for the Trust Fund Recovery Penalty

Per § 6672 of the Internal Revenue Manual:

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 for a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.

Usually, the corporation is well-intentioned and truly believes that it will be able to pay back the unpaid deposits in a relatively short period of time (i.e. before the IRS comes calling). In practice, however, this rarely happens.

What is more common is that the corporation is forced to continue to pay only the net payroll and use the IRS payroll tax funds to pay other corporate bills. After several successive quarters of diverting IRS payroll taxes, the IRS finally issues notices demanding payment of the undeposited taxes, plus interest and penalties.

If the company does not and cannot pay off the entire delinquent debt, including penalties and interest, the IRS will conduct interviews of its key corporate employees to determine who in the organization was responsible for the company’s failure to comply with the law. Responsible persons are assessed what is known as a Trust Fund Recovery Penalty  which is equal to the amount of the federal withholding taxes and FICA and medicare taxes withheld from employees pay. 

The interviews are called Form 4180 interviews because the form the IRS collection agents are required to complete while conducting the interview is IRS Form 4180.

Generally, the IRS determines responsibility by determining which corporate employees, shareholders, directors and/or officers who, during the periods of non-compliance, made decisions regarding which creditors of the company received payment and which did not. The IRS determines this by examining the bank signature cards, reviewing the businesses canceled checks and corporate documents and conducting interviews of third parties.

Lectric Law Library provides a good, brief summary of the law:

RESPONSIBLE PERSON – The “responsible person” penalty is imposed pursuant to 26 U.S.C. S 6672: 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, . . . shall . . . be liable to a penalty equal to the total amount of the tax . . . not collected, or not accounted for and paid over.

The IRS may recover a § 6672 penalty only if it shows that the individual (1) was a “responsible person ” and (2) acted willfully in failing to collect or pay over withheld taxes. Davis v. United States, 961 F.2d 867, 869-70 (9th Cir. 1992).

A person is responsible for the payment of trust fund taxes for purposes of the § 6672 penalty if he had the “final word on which bills should or should not be paid.” Maggy v. United States, 560 F.2d 1372, 1374 (9th Cir. 1977). The “final word” “does not mean `final’ but instead `the authority required to exercise significant control over the corporation’s financial affairs, regardless of whether[the individual] exercises such control in fact.’” United States v. Jones, 33 F.3d 1137, 1139 (9th Cir. 1994)

See also Alsheskie v. United States, 31 F.3d 837, 839 (9th Cir. 1994). A person who does all he can to cause taxes to be paid, and whose efforts are rejected by those with more control, is not a “responsible person.”

It is possible that a person who is not a shareholder, director or officer will be found to be responsible and an individual who is a shareholder and director will be found not responsible. Many unsuspecting bookkeepers have been hit with a trust fund penalty because their bosses had them sign all the checks and the IRS used this fact as evidence that the bookeeper and not the owner/President chose which creditors to pay.

There are two compelling reasons why you should never attend a 4180 interview without having an attorney present. First, at the end of the interview the IRS agent will require you to sign the form 4180 under penalties of perjury. You don’t want to say something that is inaccurate and unwittingly open yourself up to a criminal perjury prosecution. Second, the IRS agent will use anything you say in the interview against you in determining whether or not you are a responsible person. Remember, the IRS wants as many people as possible to be responsible because that increases its chances of collecting the penalty.

The IRS can go after each responsible person or it can choose to focus its collection efforts on only one person. It has no duty to be “fair” and collect the same amount from each responsible person, they can assess different periods based on who they deem as willful and responsible for the non-payment of the trust taxes.

If you were in a business that didn’t pay its payroll taxes and have been or think you might summonsed for a 4180 interview, contact an experienced enrolled agent who unlike attorneys (who usually are spread thin by working several areas other than tax law), deal with nothing other than representing their clients before IRS.

The IRS makes over 50,000 TFRP assessments each year, averaging $21,000 per responsible person.

For each defunct business owing payroll taxes the IRS on average finds 1.6 responsible persons but it is not uncommon for several people to be declared responsible. The IRS can still assess the trust fund penalty if the business is still open. Then they have not only the individuals to collect from but also the business.

Revenue Officers will conduct what they call the Trust Fund Recovery Penalty Interview and begin by putting together a list of people with any authority over the businesses finances.

• Who made the financial decisions in the business?
• Who signed or had authorization to sign on the checking account?
• Who had the power to pay or direct payment of bills?
• Who had the duty of tax reporting?

To get this information the officer may interview everyone whose name comes up when she asks the above four questions. She looks at bank and corporate records for the names on bank signature cards, and to find out who actually signed checks and who were corporate officers.

The Trust Fund portion of payroll taxes is not a dischargeable tax debt in bankruptcy, however they can be resolved through an Offer in Compromise, payment plan, or placed into a not currently collectable status.

Appealing the Trust Fund Recovery Penalty

Once you are found to be a responsible person by a revenue officer, you will be sent a notice and a tax bill. The revenue officers decision can be protested to the appeals division.

From the date of the initial notice you have 60 days to file an appeal. To do this you must prepare a written response protesting the decision to the Appeals Office. If you fail to use your appeal rights, 60 days from the initial notice (notice number 1153), the assessment becomes final. If you refuse to pay the IRS can go through its normal collection process for a tax debt, i.e. file a lien, and then levy.

Even by simply filing the appeal of the proposed TFRP assessment it will buy you time- even if you know you are clearly responsible. An IRS collector can’t take enforced collection action. Another advantage for filing an appeal is that interest does not run during the time an appeal is being considered, which could give you time to catch up on the payment. For example, if you are eventually found responsible for $50,000 in unpaid payroll taxes and your appeal process takes a year, you’ll avoid paying approximately $3,500 in interest.

If you lose your appeal and feel you truly are not responsible go to court. You can no longer sue in tax court, but may be able to find some success in the U.S. District Court nearest you or in the U.S. Court of Claims. In 2006 Tax court doesn’t require you to pay the IRS any tax before filing our suit. However, if you sue in a district court or the court of claims, you must first pay at least some of the taxes claimed before you file a lawsuit seeking a refund. The minimum you must pay is equal to the unpaid payroll taxes due for one employee for one quarter of any pay period.

We have laid out the process in plain English, but the truth of dealing with the IRS is that it may not be this simple.

Hire an Experienced Licensed Representative

We offer a full tax analysis without cost or obligation. Contact me today and we will have a licensed tax professional go into more depth about your particular situation and we can advise you on what programs you qualify for and send you off in the right direction.

Internal Revenue Code § 6672 liability is referred to as the "Trust Fund Recovery Penalty or “Civil Penalty” and is the legal basis for the federal government to collect “trust fund taxes. In the context of employment taxes, the term “trust fund” taxes refer only to taxes withheld from employees for the payment of federal income tax and one-half of the Federal Insurance Contributions Act (FICA) that fund Social Security and Medicare programs. Such taxes are reported on the Form 941 tax return that is filed by an entity with W2 employees on a quarterly basis and reports the gross wages paid, the federal income tax withheld, the sum of employer’s and employees’ FICA liability, and the deposits paid. After the deposits (if any) are accounted for, the taxes still owing are to be paid with the return. The unpaid balance due from these taxes may be the subject of a § 6672 assessment.

§6672 allows the IRS to collect the unpaid trust fund tax liabilities of corporations and other types of limited liability entities from the personal assets of those persons who were responsible for the non-payment of such taxes to the government. Thus, the veil of the entity will not protect the income and assets of the individual from collection of a Trust Fund Recovery Penalty assessment.

The factual pattern is usually one where an entity is suffering financial strain and is unable to pay its creditors for the purpose of remaining operational. Thus, the owners and/or officers of the entity divert the payroll taxes withheld to pay non-IRS creditors instead of forwarding the money to the IRS to pay the payroll tax debts. The individuals who made the decision to divert the money can be held personally liability for the payroll tax debts.

Trust fund deficiencies may be assessed against several persons for the same tax period liabilities owing. The policy permitting joint and several liability is to assert the penalty for collection purposes and allow the individuals to dispute the collection of the penalty assessment among themselves. However, the IRS cannot collect more trust fund taxes than are owed by the business. In the case of overpayment, the last person to pay the trust fund debt owed that caused the overpayment is entitled to a refund. Internal Revenue Manual § 5.7.7.6.

Generally, a §6672 assessment will be assessed when:

1. The individual was a responsible person (someone who has the status, duty, and authority over the financial decision-making) within the liable entity; and
2. The individual willfully failed to collect, truthfully account for, and pay over trust fund taxes (by knowingly paying other creditors while the trust fund taxes were due to the IRS).

The determination of who is a responsible person has been defined by administrative rulings and case law, not the Internal Revenue Code. Responsibility attaches when a person has the authority to decide which creditors to pay and when to pay them (or not pay them). Thus, the test is one of control of the payment responsibilities of the entity and not one of title.

The element of willfulness has been defined by case law and the Internal Revenue Manual, not the Internal Revenue Code. Willfulness for §6672 purposes merely requires a voluntary, conscious, and intentional decision not to remit funds properly withheld to the government.

Internal Revenue Manual, §5.7.5.1 reads that the §6672 Penalty “will normally not be assessed when the likelihood of successful collection is minimal.” Therefore, in practice, the determination of whether a §6672 assessment should be made is a three element test that includes potential collectibility, when §6672 is read together with Internal Revenue Manual §5.7.5.1.

The IRS generally has three years to assess the Trust Fund Recovery Penalty or Civil Penalty assessments are usually investigated and proposed by a Revenue Officer in the IRS Collection Division. If a Trust Fund Recovery Penalty investigation cannot be avoided by resolving the outstanding payroll liabilities, the Revenue Officer will normally examine the entity’s tax returns, bank records, signature cards, Articles of Incorporation, Bylaws, canceled checks, corporate minutes, and corporate resolutions to establish the responsibility and willfulness elements needed for assessment.

Revenue Officers will also attempt to interview individuals who may have knowledge of the entity’s decision making processes and financial condition. Revenue Officers will then attempt to conduct Form 4180 interviews with those individuals who may have had a role in diverting the money. The Form 4180 interviews are designed to elicit admissions to support that a §6672 assessment is warranted.

If the Revenue Officer’s recommendation for assessing a Trust Fund Recovery Penalty is approved by the Revenue Officer’s group manager, a 60-day letter is issued to those taxpayers that were deemed responsible for diverting the money. The 60-day letter notifies them of the proposed assessments. After receiving a 60-day letter, a taxpayer may dispute the proposed assessment of the trust fund recovery penalty prior to it being assessment (pre-assessment appeal) or after it has been assessed (post-assessment appeal). One difference between the two options is that interest will not accrue if the appeal is made before the penalty is assessed. If a taxpayer does not provide a response within the required 60 days, the Revenue Officer will assess the Fund Recover Penalty and the IRS will begin to pursue collection efforts against the taxpayer. The taxpayer can then either pay the penalty or pursue a resolution with the IRS.

If you are looking for help, which I suggest you do when dealing with the Trust Fund Recovery Penalty, please contact me and I will get back with you shortly. 

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