By federal law, employers are required to withhold certain funds from their employees’ wages and pay them to the IRS in the form of income and payroll taxes. 26 US Code Sec. 6672(a) provides that “any person required to collect, truthfully account for, and pay over any tax,” who willfully fails to do so, is liable “to a penalty equal to the total amount of the tax” not paid over.
The term “any person” is important because it allows the IRS to hold certain people at a business personally liable for the employer’s unpaid payroll taxes. This distinction is significant, as it neutralizes one of the primary benefits of having a legal business entity, namely to limit the personal liability of those to run the business. Thus the “Limited Liability,” in Limited Liability Company, or LLC.
A responsible person is a person or group of people who has the duty to perform and the power to direct the collecting, accounting, and paying of trust fund taxes. The IRS can personally prosecute any “responsible person” for a business’s failure to pay payroll taxes, even if they aren’t an owner of the business. This can include an officer or employee of a corporation, a member or employee of a partnership, a corporate director or shareholder, a member of a board of trustees of a nonprofit, and even payroll service providers.
Recently, businesses collect funds from employees for the purpose of paying payroll taxes, and then redirect the funds to use for their own benefit have become priority targets for the IRS. It bears repeating that the risk is not limited to losing one’s business. Rather, both personal liability and for criminal charges are very real risks.
IRS investigations are complex, and defending any lawsuit costs everyone involved time, stress, and money. Stay ahead of the curve with the counsel of an experienced and trustworthy tax attorney.
The Trust Fund Recovery Penalty is Scary….because it is Real.
The IRS website* explains that “to encourage prompt payment of withheld income and employment taxes...Congress passed a law that provides for the TFRP.” The Trust Fund Recovery Act is thusly named because the employer withholds money from an employee’s paycheck and holds money “in trust” until the funds are sent in as a federal tax deposit.
Once IRS determines a responsible person for a willful violation of TFRP, they provide a letter stating that the person 60 days to appeal. The IRS website* provides a PDF to explain appeal rights and the application process at Publication 5. Unless you appeal that 60-day letter will be followed by a Notice and Demand for Payment.
What Does it Mean to Be Willful?
Demonstrating willfulness is a crucial aspect of the prosecution’s burden in almost any criminal tax case. In general, courts have held that willfulness is present if a taxpayer knew or recklessly disregarded a certain duty or obligation.
A big Red Flag for the IRS in these cases is when a business uses available funds to pay other creditors. A struggling business, or even a healthy business experiencing cash flow issues. When a business pays creditors it would otherwise be unable to pay with the “trust fund” employment taxes, it is an indication of willfulness. In other words, the fact that a business had debts it could not pay will be used as evidence of willfulness to commit the crime. This is because those are the circumstances that are most likely to give rise to the commission of this crime.
It is important to understand that acting under distress or even duress is not likely to excuse willful misconduct. Often defendants will argue that they acted under the stress of extreme hardship or extenuating circumstances, hoping the court will show leniency. However, a court is unlikely to take into account the financial circumstances of a person or the company in determining whether the failure to pay an owed tax was willful.
According to the IRS website,* “the amount of the penalty is equal to the unpaid balance of the trust fund tax and the penalty is based on the unpaid amount of collected excise taxes.” In addition to the back-taxes and interest that will be owed on unpaid trust fund taxes, the trust fund penalties can increase exponentially over time. To make matters worse, the penalties cannot be discharged in bankruptcy.
As severe as the financial penalties for failing to pay over trust fund taxes can be, even worse is the reality that failing to pay trust fund taxes can lead to criminal charges and prison time. Historically, criminal charges have generally been reserved for the more egregious cases, or as a threat used to the government’s advantage in plea bargaining, but recently the IRS is showing that they are more and more willing to pursue criminal charges against those who willfully violate their payroll tax duties. IRS is aggressive in assessing the trust fund penalty, and becoming more aggressive in pursuing criminal cases.
If you or your company has received notice of an IRS audit, or received any communication from the IRS which you do not understand, it is imperative that you contact an experienced tax attorney as soon as possible. Mistakes made early in the process, could lead to otherwise avoidable consequences such as seizure of assets, financial penalties, and even jail time.
I Have a Small Business. Is the IRS Really Looking at Me?
Assuming that they will fly under the IRS’s radar is one of the primary reasons small business owners can be especially vulnerable to prosecution under the trust fund recovery act. Small businesses lack the resources to implement internal control systems and safeguards. In contrast, larger business not only account for such safeguards in their annual budgets, they also often have teams of attorneys on retainer in the event of a mishap.
In contrast, many small businesses out of necessity delegate accounting responsibilities and job functions to personnel far exceeding their expertise. The US Tax Code is one of the most complicated that has ever existed. Even the most honest, competent, and diligent of employees faces countless opportunities to run afoul of the IRS. If a person actively seeks to commit financial fraud, a small business often lacks the oversight to detect it until it is far too late. Except to the extent that it is a defense to willfulness, sloppy accounting is an imperfect excuse to say the least.
Avoiding the TFRP
According to the IRS website, “you can avoid the TFRP by making sure that all employment taxes are collected, accounted for, and paid to the IRS when required. Make your tax deposits and payments on time.” An experienced tax attorney can help you protect your business and personal assets, even your freedom.
Additional information on employment taxes can be found Publication 15, and Form 941 at the IRS website.*