Payroll Taxes & Trust Fund Recovery Penalty

What happens if you don't turn over funds withheld from your employees' paychecks to the Internal Revenue Service (IRS)? The IRS comes after this money and imposes a penalty. This penalty, the Trust Fund Recovery Penalty (TFRP), is one of the IRS's largest. Ignoring it could lead to tax liens and property seizure. If you receive a letter from the IRS stating that the agency will start a TFRP assessment against you, you should contact a tax attorney as soon as possible.

Trust Fund Recovery Penalty

If you're an employer, you're responsible for withholding certain funds from your employees' wages. These funds include Medicare and Social Security contributions (together known as Federal Insurance Contributions Act or FICA taxes). They also include personal income tax. The IRS requires employers to withhold these funds and hold them “in trust” until they deposit them with the IRS. For this reason, these taxes are referred to as trust funds.

When you willfully neglect your obligation to deposit these trust funds with the IRS, the agency will impose the TFRP to recover the taxes you owe. The IRS takes collecting trust funds seriously and has no problem seizing your personal assets to retrieve their money.

Who Is Subject to the TFRP?

The IRS doesn't assess the TFRP against employees if their sole function was paying bills as directed by a superior. Only those responsible for collecting and paying payroll taxes can be subject to the penalty—and only if they willfully failed to collect or pay them.

Who can be responsible for the TFRP?

  • An employee of a corporation
  • A member of a partnership
  • Sole proprietors
  • A corporate director
  • A board of trustees member
  • Someone with authority to control and disburse funds
  • Payroll Service Providers (PSP)
  • Professional Employer Organizations (PEO)

What does the IRS consider willfulness?

  • The responsible person must or should have been aware of the outstanding taxes
  • The responsible person intentionally disregarded the law or was clearly indifferent to its requirements

You don't need malicious intent for the IRS to consider you willful. Both intentional and negligent disregard can implicate you when it comes to the TFRP. If you use business funds to pay other creditors before you pay your trust funds to the IRS, the IRS considers it willfulness as well.

What Happens When the IRS Assess a TFRP?

If the IRS determines that you willfully failed to turn over taxes you were entrusted with, the agency will notify you via letter. The statute of limitations on assessing a TFRP is 3 years, provided that there are exceptions to prolonging this statute.

Before the assessment starts, the IRS will request documents from you, such as bank statements and canceled checks. They will also ask who has access to the company bank accounts, bank cards and who pays bills. The agency might also request your articles of incorporation or partnership contracts.

The IRS wants to know who in your company is in charge of the money and where the money is going. After gathering this documentation, the IRS agent responsible for your TFRP assessment will single out people from your company who may be responsible for payroll and liable for the TFRP. The IRS will then interview these people in a Form 4180 interview.

Once the IRS sends a letter notifying you of the TFRP, you have 60 days to appeal. If you don't respond, the IRS will then send you a Notice and Demand for Payment. After you receive this notice, the IRS can issue a tax lien or levy against your property to collect the payment.

What's the Penalty?

The TFRP amounts to the unpaid income taxes withheld plus the employee's portion of withheld FICA taxes. The TFRP basically doubles what you owe. You still owe the original withheld amount, but with the penalty, you now owe that amount again.

Most of the IRS' other penalties are a percentage of the original tax debt owed—even tax evasion doesn't have such a high penalty. For this reason, you must ensure you deposit your payroll taxes with the IRS by their due date. If you cannot pay the full amount, then a tax attorney can advise you on a possible settlement or an installment agreement with the IRS to pay off the debt.

An experienced tax attorney can help you deal with a TFRP from the IRS and find the best solution for your business.

The California Version of the TFRP

Employers in California also have a responsibility to hold funds in trust and deposit them with the Employment Development Department (EDD). The EDD is the California state agency in charge of collecting payroll taxes.

If you're an employer in the state of California, you must withhold the following four taxes and funds from your employees' paychecks:

  • Unemployment Insurance
  • Employment Training Tax (only certain industries)
  • State Disability Insurance
  • California Personal Income Tax

The EDD has a penalty similar to the TFRP for those who do not transfer their withheld funds. According to the California Unemployment Insurance Code, § 1735, the EDD can penalize businesses or persons responsible for EDD payroll taxes with 100% of the amount owed.

The EDD penalty amount is virtually the same as the IRS, the IRS can hold owners of a business personally liable for the tax debt for delinquent payroll taxes. In California, the EDD can hold individuals liable. For example, if your delinquent state payroll taxes amount to $50,000 and accrue interest of $12,500, you could be personally liable for 100% of the total, $62,500. To collect their debt, the EDD can issue a tax lien against you.

What to Do If You've Received Notice of TFRP

If the IRS or the EDD sends you notice of a TFRP or similar penalty, you must act quickly to resolve the matter. You only have 60 days to appeal. To avoid making any costly mistakes and to find the best solution for your business, contact an experienced tax professional to deal with these agencies on your behalf. Contact a California Tax Attorney today to set up an initial consultation and discuss your options.

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