Navigating the IRS Trust Fund Recovery Penalty

If you have employees or handle payroll for a business, you need to withhold and pay payroll taxes. Referred to as payroll taxes, these taxes include Medicare and Social Security contributions and income taxes paid by your employees and withheld from their checks by you. 

If you don’t make these payments, you can face the Trust Fund Recovery Penalty. One of the IRS’s steepest penalties, the TFRP can apply to individuals as well as businesses. It’s completely legal for the IRS to “pierce the corporate veil” on this one. 

To help you understand how the TFRP works, this article explains the ins and outs including how the IRS determines responsibility, what to expect if you’re liable, and how to appeal if you disagree with the penalty.

Want help now? Then, contact us at Damien’s Law today.

What is the Trust Fund Recovery Penalty? 

The Trust Fund Recovery Penalty is the penalty the IRS assesses when taxpayers don’t pay payroll taxes withheld from their employees paychecks. The penalty is 100% of the withheld taxes, and the IRS can hold a variety of individuals accountable, not just businesses. 

For example, suppose you’re a small business owner with employees on the books. In that case, you are responsible for deducting certain taxes from your employee’s paychecks and paying them directly to the IRS. If you willfully fail to do so and, for example, use the money for other business expenses, you could be held personally responsible for the unpaid taxes through the TFRP.

However, the penalty doesn’t just get assessed on business owners. It can apply to any individual who was responsible for remitting withheld taxes and failed to do so. For instance, say you’re the accountant or bookkeeper for a company, and you make a call to buy more inventory instead of paying payroll taxes. Then, the IRS may label you as responsible and attempt to assess this penalty against you.

Types of Taxes Covered Under TFRP 

There are several types of taxes you are required to withhold from your employee’s wages, including federal income tax, Social Security tax, and Medicare tax.

These taxes are called trust fund taxes as they are held “in trust” until they are paid to the IRS for your employees. You don’t have to put the money into a trust fund or any type of special account. Basically, the government is trusting you to take the taxes from your employees and bring them to the government.

In addition to withholding these taxes, you must also pay employer taxes that match your employees’ Medicare and Social Security contributions. The TFRP only applies to withheld payroll taxes, not your matching proportion.

Depending on the laws in your state, you may also have to withhold state income taxes. If you don’t pay those, the TFRP doesn’t apply. Instead, you’ll face whatever penalties your state applies to unpaid withholding taxes.

Calculating the Trust Fund Recovery Penalty

Here’s a quick example. Say that you pay an employee $1,000 in wages. They owe $62 in Social Security, $14.50 in Medicare, and $100 in income tax. You withhold those amounts ($176.50) and pay them $823.50. When it’s time to pay your payroll taxes, you owe $176.50 for the withheld taxes plus the employer match of $76.50 for Social Security and Medicare. 

Now, if you don’t pay any of it, you will only face the TFRP on the $176.50. You won’t incur it on the $76.50 that you owe for your matching payments. Thus, the penalty will be $176.50 as it’s 100% of the unpaid trust fund taxes.

However, that’s not the only penalty you’ll face. In most cases, you’ll also incur a failure-to-deposit penalty, which ranges from 2 to 10% of the total payment due (the amount withheld plus the employer portion of the taxes). If you file your payroll return late, you’ll also incur additional late filing penalties. Interest accrues on all of the late payments and penalties.

How the TFRP is Assessed 

The TFRP can be assessed against any business and/or individual who is responsible for overseeing payroll tax payments and who willfully fails to collect or pay them. In this context, wilfully means you are acting voluntarily, knowingly, and intentionally. For example, if you pay other business expenses instead of the withholding taxes, the IRS could determine this to be a willful act.

Identifying Responsible Persons 

Anyone who makes the decision not to pay withheld payroll taxes can be held liable for this penalty. Typically, that includes owners and partners, but it can also include employees with financial responsibilities such as accountants and bookkeepers. Even a payroll company that your business hires to handle payroll may be held liable in certain situations.

The Trust Fund Recovery Penalty Process 

The IRS may figure out that your business didn’t pay payroll taxes by inconsistencies on tax returns, reports from third parties, whistleblowers, or through payroll tax audits.

If the IRS has identified your business as failing to remit federal payroll taxes, they will begin investigating to determine the persons responsible and what actions will be taken. Here’s a breakdown of the TFRP process:

• Identifying responsible persons: As noted above, the IRS has several ways to identify the person responsible for TFRP. If you are identified as the responsible person, you will receive Form 2751 and Letter 1153, Proposed Assessment of Trust Fund Recovery Penalty, outlining the proposed penalty amount and instructions on next steps. More on Form 2751 and Letter 1153 below.
• Wilfulness evaluation: Next the IRS must determine if the failure to pay payroll taxes was wilful. They do this by gathering evidence, such as your financial records and tax filings, and may conduct an interview with you and other leading individuals within your business.
• Notice of intent to assess: If the IRS determines you acted wilfully and are subject to TFRP, they will issue you a Notice of Intent to Assess and Collect.
• Opportunity to respond and appeal: If you disagree with the proposed penalty, you have the right to appeal. More information on ways to appeal is below.
• Final assessment and collection: If you agree with the proposed penalty or the IRS rejects your appeal, the IRS will send you a final determination of the TFRP assessment, including any actions that may be taken against you.

What is Form 2751? 

Form 2751 (Consent to Assessment and Collection) is sent when the IRS believes you are responsible for failing to withhold or pay employment taxes and outlines the proposed TFRP against you. If you agree with the proposed penalty, all you need to do is sign and return this form using the enclosed envelope to acknowledge your agreement. Then, you need to make arrangements to pay the penalty.

What is Letter 1153? 

Along with Form 2751, you will receive Letter 1153 (Proposed Trust Fund Recovery Penalty Assessment). The primary purpose of this letter is to notify you that the IRS is proposing to assess the TFRP against you, and have deemed you responsible for wilfully failing to withhold and/or pay employment taxes.

Typically, Letter 1153 is issued after the IRS has conducted an investigation and outlines the specific tax periods and amounts for which the TFRP is proposed. The letter also outlines your right to appeal and how to do so if you disagree with the penalty.

Trust Fund Recovery Interview 

Before assessing this penalty against an individual, the IRS will interview them. During this interview, the IRS agent will ask you questions about your role and your involvement in financial decisions. Some questions you may be asked include:

• How involved are you in the business’s financial affairs?
• Did you make decisions regarding which bills got paid?
• Do you oversee payroll tax payments?
• Were you aware of any unpaid employment taxes?
• Did you take any actions to address outstanding tax liabilities?

What is Form 4180? 

Before your interview, you will receive Form 4180, which includes all of the questions the IRS officer will ask during the interview. This will help you prepare beforehand so you can familiarize yourself with the questions, and gather any other information that may be relevant to the interview.

Form 4180 includes six sections:

• Person Interviewed: Your personal information, including your role within the business.
• Business Information: The business’s information, including financial institutions used for transactions and the names of corporate members.
• Responsibilities: Your responsibilities within the business, dates you performed these responsibilities, and names of any other individuals who shared responsibilities.
• Knowledge/Wilfulness: These questions determine your knowledge and wilfulness regarding the TFRP, including when you first became aware of the delinquent taxes.
• Personal Liability for Excise/Payroll Tax Cases: Questions regarding your involvement in excise and/or payroll taxes, including your knowledge of any unpaid taxes and your role in decision-making about tax payments.
• Signatures

During your interview, the revenue officer will go through all of the relevant sections to determine if you are responsible. You do not have to fill out the form yourself, and a copy of the filled form will be sent to you after the interview for you to review.

Challenging TFRP Assessment 

If you have received Letter 1153 and believe you have been wrongly held personally liable for the TFRP, you have the right to dispute the assessment and appeal the decision.

How to Dispute the TFRP Assessment 

If the IRS has determined that you are personally liable for unpaid trust fund taxes, and you disagree, you have the right to dispute the TFRP assessment within 60 days of receiving your Letter 1153.

To do this, you will need to mail a written appeal to the Appeals Office. If the proposed penalty is $25,000 or less, you can submit a Small Case Request. For this, you will need to:

• Attach a copy of your Letter 1153
• Make a statement that you want an appeals conference
• Include a written explanation listing the issues you disagree with and why. 
• Attach any relevant support documentation.

If the proposed penalty for each period is over $25,000, you will need to submit a formal written protest. You can also use this option if you owe less than $25,000 but don’t want to use the small case procedures. Your request should include:

• Your personal information, including your name, address, and social security number
• A statement that you want an appeals conference
• A copy of your Letter 1153
• A list of the issues/findings you disagree with
• A sworn declaration outlining your disagreement and the reasons why the penalty shouldn’t apply to you. The declaration should also include specific dates, names, and amounts to back up your claim.

In some cases, it may be beneficial to set up a meeting with your IRS revenue officer to discuss the assessment and your reason for disputing. Contact your revenue officer within ten days of the date on your Letter 1153.

Pay attention to deadlines carefully. Missing deadlines can lose you the right to appeal.

Best Practices for Avoiding TFRP Liabilities 

At 100%, this penalty is steep, but you can easily avoid it if you pay your payroll taxes. Keep these tips in mind:

• Budget for payroll taxes—when you pay your employees, you can’t just think about the amount on the paycheck, you also have to consider the taxes you owe.
• Use payroll software—the right software will help you calculate the taxes, and some software will even withdraw the tax payments from your bank account and send it to the IRS.
• Be aware of your personal liability risk—if you know that your employer isn’t paying payroll taxes and you’re concerned that you might be personally liable, talk with an attorney about your options.

If you have a large business with a lot of people involved in the finances, you may want to conduct audits to help you ensure compliance and avoid errors.

When to Speak to a Tax Professional 

Here’s when you might want to reach out to a tax pro for help:

• You’re hiring employees for the first time and want help with tax planning.
• You’re setting up payroll and want to ensure you never face this penalty.
• You’ve gotten behind on your payroll taxes and want help dealing with the IRS.
• You’ve received a letter to your business or to you personally about the TFRP.
• The IRS has already assessed the TFRP against you.
• You want to appeal a TFRP.
• You owe a TFRP but aren’t sure how to pay it.
• You’re dealing with any other payroll tax or TFRP problems.

Regardless of what you’re dealing with, Damiens Law can assist you. Please contact us for a free consultation today.

FAQs

How Much is the TFRP? 

The TFRP is equal to the unpaid amount of withheld payroll taxes, including federal income tax, Social Security contributions, and Medicare payments. That means that the amount of the TFRP can vary depending on the amount of payroll taxes that were withheld but not remitted to the government. 

What if I Can’t Afford to Pay the TFRP? 

The IRS offers payment plans that allow you to pay off your tax debt over time in manageable installments. If you incur a TFRP that you can’t afford to pay, you can request a payment plan directly from the IRS, either online or by submitting Form 9465 (Installment Agreement Request).

Another option is a penalty abatement to reduce the TFRP. If you can demonstrate that your failure to comply with payroll tax requirements was due to circumstances beyond your control, such as illness, natural disaster, or financial hardship, you may qualify for penalty abatement based on reasonable cause.

Note that it’s very difficult to waive this penalty. There are many cases where people request relief from this penalty due to cancer, heart attacks, or other serious issues, and the IRS refuses to remove the penalty. However, that stringent line typically comes into play when the person hasn’t been paying payroll taxes for years, not when you’re talking about missing just a few payments.

What Triggers the IRS to Assess a TFRP? 

There are several things that could trigger the IRS to assess a TFRP, including, but not limited to:

• Failure to pay payroll taxes
• Pattern of non-compliance
• The IRS suspects misuse of funds
• Audits and examinations
• Information received from third parties

Can Employees be Liable for the TFRP? 

For an employee to be held liable for the TFRP, the IRS must establish that the individual meets the criteria of a responsible person and that they acted willfully in failing to comply with payroll tax requirements. A responsible person is someone who has control over spending money and making decisions about payroll taxes. In certain cases, the IRS may hold employees such as CFOs and payroll managers accountable. This is especially true when they have significant control over the company’s financial affairs.