How to Avoid and Resolve Trust Fund Recovery Penalties: Guide for Employees and Third Parties

Trust Fund Recovery Penalty

The IRS Can Assess Trust Fund Recovery Penalties Against Employees, Accountants, and Other Third-Parties. If the IRS contacts you about a trust fund recovery penalty, you need to respond carefully.

The IRS is extremely serious about payroll taxes — if a business fails to pay these taxes, the agency may assess trust fund penalties equal to the amount of the tax as well as other penalties and interest.

The trust fund recovery penalty is unique because it isn't just assessed against the business or its owners. The IRS can assess this civil penalty against employees and even third parties that have been contracted to take care of payroll. If you're liable for unpaid payroll taxes, you can also face criminal penalties.

If the IRS is investigating your involvement in unpaid payroll taxes, do not take this issue lightly. Get help from an experienced tax attorney or another tax professional licensed to represent you in front of the IRS.

Why Is the IRS So Aggressive About Trust Fund Recovery Penalties?

Payroll taxes include Social Security contributions, Medicare premiums, and federal income tax paid by employees through their paychecks. By law, employers must withhold these taxes from their employees' paychecks and send these amounts to the IRS as well as matching amounts for the employer's contribution to Social Security and Medicare.

Social Security and Medicare payments are critical to fund these programs. If employers don't make these payments, the government will not have adequate funds to make Social Security payments or to fund Medicare coverage.

Federal income taxes withheld from paychecks are supposed to cover employees' tax liabilities, but they can also be refunded to the employee if they earn a tax refund. Again, the government will struggle to make these payments if they don't collect the funds.

Essentially, the IRS sees unpaid employee payroll taxes as theft. Employers have withheld the funds from their employees' pay, and if they pocket the funds or use them for other purposes instead of sending them to the IRS, they are ostensibly stealing from both the employee and the government. If you as an employee get caught in the crossfire of an employer's unpaid payroll taxes, you can face serious financial and legal consequences.

Who Is Liable for Trust Fund Recovery Penalties?

Obviously, the owner of the business, corporate officers, partnership members, trustees, and directors can be held liable for trust fund recovery penalties. With most business taxes and IRS penalties, the list stops at those responsible parties. But trust fund taxes are different.

Anyone who had a duty to withhold and remit the payroll taxes can also be held responsible. This includes employees, stockholders, personal representatives, lenders, creditors, accountants, bookkeepers, employees of payroll companies, and attorneys.

To be held liable for a trust fund recovery, you must have willfully failed to collect and pay the tax. But what does this mean? How does the IRS assess that you were responsible and that you willfully ignored your obligation? Keep reading for an overview of the process.

Determining Liability for Trust Fund Recovery Penalties

To assess responsibility for trust fund taxes, the IRS revenue officer doesn't just look at the person's job title. They take several factors other factors into account, and they assess whether or not the person does the following:

Manages day-to-day company affairs.
Signs checks for the business.
Refuses to sign checks and thus prevents the payment of the tax.
Makes financial decisions.
Controls payroll disbursements.
Makes withholding deposits.
Prepares payroll tax returns.
Decides which bills get paid first.
Hires or fires employees.

Trust fund recovery liability has gone through multiple court cases, and while the courts pay close attention to the person's role in the company, they tend to pay particular attention to the issue of prioritization. If you decided that the company should pay other bills instead of payroll taxes, you may be considered liable.

To assess liability, the revenue officer will request financial documents such as canceled checks or business records that may indicate who is responsible. If the business doesn't provide the information voluntarily, the IRS can issue a legal summons.

What Is Willful Failure to Pay Payroll Tax?

To be held liable for payroll taxes and trust fund recovery penalties, you must have acted willfully. This doesn't mean that you must have demonstrated malicious intent to defraud the government. Willfulness just means that you made a voluntary and conscious decision not to pay the trust fund taxes.

For example, if you decided to pay the electric bill instead of covering withholding, you may be held responsible.

What Should You Do If the IRS Thinks You're Liable for a Trust Fund Recovery Penalty

If the IRS contacts you and says that you might be held liable for this tax, do not take the issue lightly. Again, these penalties are severe, and they can cost a lot of money.

Ideally, you should retain legal counsel as soon as possible. If multiple people might be considered liable, they should each get their own lawyer. Otherwise, conflicts of interest may arise.

What to Expect If the IRS Thinks You're Liable for Trust Fund Recovery Penalties

If the IRS thinks you might be liable for a trust fund recovery penalty, the agency will request an interview with you. The purpose of the interview is to get you to admit liability or reveal information that will establish your liability.

You can go to the interview on your own, but to protect yourself, you should strongly consider bringing legal representation. If you don't voluntarily respond to the interview request, the IRS can summon you. At that point, failure to appear can lead to contempt of court.

What Happens at a Trust Fund Recovery Interview?

Also called a Form 4180 interview, the trust fund recovery interview consists of a variety of questions designed to assess your role in the company and your potential liability for the trust fund recovery penalty.

You will not receive this form in advance. Instead, the revenue agent will bring the form to the interview and fill it out based on your answers. The length and breadth of the interview can vary based on the situation.

For example, the first page of Form 4180 helps the revenue officer decide if they should go forward or abandon the inquiry. The interviewer may also ask questions from different parts of the form depending on if you are an employee of the company or an employee of a third-party payroll service.

In general, the questions are designed to determine your level of responsibility and decision making in the company. Do you have the authority to decide how the company's money gets spent? Did you contribute to decisions that lead to the payroll tax not being paid? Did you know about the unpaid tax? Could you have done anything to change the issue?

What Happens If the IRS Assesses a Trust Fund Recovery Penalty Against You?

If the IRS decides to assess a trust fund recovery penalty against you, the agency has 10 years to collect it. The IRS has the power to use a vast range of collection actions including issuing federal tax liens, seizing your wages and other income, and levying your bank account or other personal and business assets.

You cannot discharge a trust fund recovery through bankruptcy. If you have the assets to cover this penalty, the IRS will use any measures it can to reclaim the penalty.

Bottom Line — What to Do If the IRS Thinks You're Liable for a Trust Fund Recovery Penalty

If the IRS contacts you about a trust fund recovery penalty, consult with a tax attorney or another tax professional experienced with this penalty. Talk with your tax professional before responding to the IRS's requests for information or interviews. Bring your tax professional to the interview and consider having them respond to the IRS's information requests.

A tax professional can help you understand your liability, and they can minimize your risk exposure. If you are held liable for this penalty, they can help you negotiate arrangements with the IRS.

Penalties for Unpaid Payroll taxes

The trust fund recovery penalty is 100% of the unpaid payroll tax. For example, if the business failed to deposit $20,000 that it had withheld from employee paychecks for federal income tax, Social Security, and Medicare, the trust fund recovery penalty would be $20,000. If the unpaid withholding tax was $1 million, the trust fund recovery penalty would be $1 million.

Additionally, there is a civil penalty of 2 to 15% of the tax for making a late deposit. If you don't file the returns, the penalty for filing late is 5% of the tax per month, up to a total of 25%. Luckily, employees cannot be held responsible for all of these fees. Liability for late and unpaid taxes generally only applies to the business or its owner.

Can You Go to Jail for Unpaid Payroll Taxes?

Generally, jail time only comes up in serious cases of tax fraud or evasion. But with payroll taxes, jail time can be a serious risk. There are many cases of business owners and other people going to jail for unpaid payroll taxes and trust fund recovery penalties. The standard jail sentence is up to five years.

Jail time is not restricted to people directly involved with the company. For instance, a banker faced a possible jail sentence because he continued to give loans to a payroll company even though he know the company was not paying the payroll tax for its clients.

Get Help With Trust Fund Recovery Penalty Cases

If you've been accused of being responsible for unpaid payroll taxes, you need to protect yourself. The trust fund recovery penalty is one of the IRS's harshest civil penalties, and you should not navigate this on your own.

To get help, use TaxCure to search for a tax professional based in your local area and experienced with this penalty.