Understanding How a Business Owner or Bookkeeper Can Face the Trust Fund Recovery Penalty for Payroll Tax Obligation Failures

Understanding How a Business Owner or Bookkeeper Can Face the Trust Fund Recovery Penalty for Payroll Tax Obligation Failures

Owning and running a business is part of the American dream. However, while running a business provides certain benefits to the owner or operator, there are also certain responsibilities that an owner or responsible party must satisfy. One of these obligations is the responsibility to collect, hold, and pay over trust fund taxes to the U.S. government. The failure to satisfy business tax obligations is something that should always be avoided because of the potential that not only the business will face penalties but also the individual owner and responsible parties.

When a business owner or a company’s bookkeeper are believed to have engaged in a payroll tax scam or some other fraudulent activity that deprived the government of revenue, business owners are often shocked at the aggressiveness of IRS and Department of Justice investigators. In many instances, business owners have described the experience of facing trust fund tax enforcement as being treated like a criminal until the party could prove his or her innocence. Working with an experienced tax lawyer can help clear your name and protect you from significant liability that can be imposed under the trust fund recovery penalty.

How Are Payroll Taxes Different than Income Taxes?

While it is tempting to think about taxes in a broad sense, it is essential to note that there are important differences between payroll taxes and income taxes. Under Internal Revenue Code §7501 Liability for taxes withheld or collected, the definition of a trust fund tax is set forth. A tax is considered part of a special trust fund for the United States “whenever any person is required to collect or withhold any internal revenue tax from any other person and to pay over such tax to the United States.” Payroll tax withholding for Social Security and Medicare are the archetypical example of trust fund taxes. When a person or entity has a trust fund tax obligation, they have a duty to collect and hold this tax revenue before remitting the revenue to the U.S. government. Since the money is only held in trust, it is actually the property of the U.S. government.

Payroll tax and trust fund tax obligations are particularly concerning because, the business owner and responsible parties like a bookkeeper or payroll processing company can face these penalties in an individual capacity. The failure to satisfy one’s obligation in regard to these taxes can and often does result in prosecution and punishment under §6672 and §7202.

When Does the Trust Fund Recovery Penalty Apply?

Under IRC §6672, the trust fund recovery penalty may be imposed individually when certain conditions are met. To start, the failure to “collect, truthfully account for, and pay over tax” must have been performed willfully. Willful conduct includes actions that involve an intentional or voluntary disregard of a known legal duty. Essentially, the trust fund recovery penalty can apply to an individual when he or she is a responsible party and he or she acted willfully. This can result in the unenviable position of being held personally liable for the unpaid tax and facing potential criminal exposure. The penalty is non-dischargeable in bankruptcy and may be enforced through an IRS collections action.

How Can I Avoid the Trust Fund Recovery Penalty?

If you are charged with acts that give rise to liability under the trust fund recovery penalty, an experienced lawyer is likely to approach the matter by trying to prove that you were not a responsible party or did not act willfully. The exact approach a lawyer will take to protect a client from trust fund penalties will turn on the facts and circumstances unique to the matter, but he or she may focus on showing that you did not fit the definition of a “responsible party.” Factors a lawyer may use to determine responsibility can include:

  • The individual’s job title and role in the company.
  • The duties assigned to the employee.
  • Whether the employee has control of the financial affairs of the business including signature authority.
  • If the employee has the authority to determine which creditors get paid.

Defending a trust fund recovery penalty matter typically requires exhaustive research and planning. Your attorney is likely to obtain corporate records, help you prepare for a Form 4180 interview, assess statute of limitations concerns under IRS §6501(b)(2), and file a timely protest to Letter 1153 as part of the preparations.

If criminal tax charges have been brought under §7202, additional preparations are necessary. It is also essential to note that referral to the California Employment Development Division for state-based enforcement proceedings by the IRS is a fairly common experience. Therefore, anytime one faces an IRS action involving payroll taxes, it is prudent to also consider how one will meet the subsequent EDD enforcement action.