Trust Fund Recovery Penalty

What is the Trust Fund Recovery Penalty Act?

The Trust Fund Recovery Penalty Act (formerly known as the 100% Penalty) was enacted in 1998 to assist the IRS in collecting back Payroll Tax Liabilities. A Trust Fund Tax is any tax that you hold “in trust” to be paid to the government.

In short, you acted as the collector of the taxes and were supposed to turn the money over to the government, but you failed to do so. In the eyes of the IRS, you have stolen from them: you were holding their money and you spent it without their permission.

A trust fund tax is any tax that you collected for the government and were supposed to turn over to the government. On the Federal level, this nearly always refers to payroll taxes though it can also include federal excise taxes.

On the state level, payroll withholding taxes and sales / use tax are both considered Trust Fund taxes and most states have similar procedures for pursuing the owners of companies personally who spend their money.

How much of the total Payroll Tax Liability is considered held in Trust?

Whenever you pay your employees payroll, you take money out of their check for Federal Income Tax Withholding, Social Security Withholding, and Medicare Withholding. The amounts that you actually withheld from their paycheck are the Trust Fund portion of your debt.

The exact calculation is complex -- but we created a Trust Fund Penalty Calculator to give you a rough estimate. If you want an exact number, call us and we will tell you what documents we need from you to calculate it.

When you pay your employees, your Company also matches the Social Security and Medicare withholding and pays that to the government too. The Company matching portions are not Trust Fund and cannot be assessed against the owners of the Company personally. Additionally, any penalty and interest that has accrued on the corporate tax accounts is not Trust Fund and cannot be assessed against the owners of the Company.

Who can be assessed the Trust Fund Recovery Penalty?

The IRS can assess anyone within the corporation who they find to be both “willful and responsible” for the nonpayment of the payroll taxes. 

The IRS defines willful as “intentional, deliberate, voluntary, reckless, knowing, as opposed to accidental” but stresses that no evil intent is required. Being willful means that you knew, or by virtue of your status should have known, that the taxes were due and you made a conscious decision to pay other bills instead. 

The responsible person is usually determined by status or position.  Ultimately, if you are the owner of a business then you are responsible automatically simply by your position within the company, but the investigation does not stop there. The IRS is going to look for who controlled the finances, signed checks, and who decided which bills were paid.  This can include outside accountants, bookkeepers, etc.

The key here is that the IRS must show that you were both willful and responsible, not just one of the two. Both conditions must exist. Therefore, a successful defense against the Trust Fund Recovery Penalty can disprove just one of these two criteria.

Is there a time limit for the IRS to Assess the Trust Fund Recovery Penalty?

The IRS is given a statute of limitations for assessment of the Trust Fund Recovery Penalty of around three years. We say "around" three years because it's actually a little more complicated than that.

The exact rule is that the assessment must be made within three years after the April 15th following the filing of the tax return. So, if you filed a 941 payroll tax return in September 2010 then the three year clock would not actually start running until April 15, 2011 and the IRS would then have until April 15, 2014 to assess the Trust Fund Recovery Penalty to whomever they found to be willful and responsible.

The 4180 Trust Fund Recovery Penalty Interview

The IRS has a form specifically used to determine “willfulness and responsibility”: Form 4180 “Report of Interview Held With Person Relative to Trust Fund Recovery Penalty or Personal Liability for Excise Tax”.  The purpose of the 4180 Interview is to both find out if you were willful and responsible, and to see who else you’ll “throw under the bus”.

Can a Trust Fund Recovery Penalty Assessment be Prevented?

Yes, though it is generally very difficult. Case law is stacked against owners of the businesses, and in many jurisdictions the courts have ruled in a manner that essentially makes both willfulness and responsibility automatic if you were the owner of the Company.

However, if you truly have a defense and can prove that you were either not willful in your non-payment or were not the person responsible for the payment of the taxes then you may be able to successfully defend yourself against assessment.

The IRS is required to notify you with Letter 1153 that they are proposing to assess you with the Trust Fund Recovery Penalty. You have 60 days from the date of this letter to file a protest to appeal that decision, which is your opportunity to present your evidence that you were either not willful or were not responsible.

The IRS can take up to one year to hear a Trust Fund protest, so an appeal can sometimes buy you enough time to find other ways to pay the debt and avoid a lien on your personal credit -- this alone is sometimes very valuable.

Can I Reduce My Personal Exposure to the Trust Fund Recovery Penalty?

Yes!

Any voluntary payment that you make to the IRS can be applied however you choose. This means that if you are making voluntary payments to the IRS, you can order them to apply your payments to the Trust Fund portion of the business debt, reducing your personal exposure dollar-for-dollar with each payment that your company makes.

This opportunity is typically short-lived and you should take advantage of it while you can -- once you enter into a formal payment plan with the IRS, one of the terms of that payment plan is that the IRS will apply all payments in their best interest.

Applying payments in the IRS' best interest means they apply it first to non-Trust Fund tax, then to Trust Fund tax, then penalty, then interest. This is obviously contrary to your best interests. If you want to reduce your personal exposure, you should pay as much of your debt as possible before entering into a formal arrangement with the IRS, and direct them to apply those voluntary payments towards the Trust Fund portion of the debt.