The Shadow of "Willfulness" in TFRP Liability

Willfulness in TFRP

How Does the IRS Define Willfulness for TFRP Cases

The IRS assesses the Trust Fund Recovery Penalty on individuals, but only if two conditions are met: responsibility and willfulness.

A responsible person is generally defined as anyone who's responsible for the business's financial decisions, but willfulness is murky and can be a lot harder to define. Simply knowing that the payroll taxes weren't paid doesn't necessarily make you willful, especially if you were following someone else's directions. That said, claiming ignorance or reliance on another person's advice doesn't necessarily mean that you weren't willful.

Key Takeaways:

The IRS assesses the TFRP on responsible individuals who willfully fail to pay payroll taxes.
Willfulness is when you voluntarily take an action, even if you didn't have malicious intent.
To determine willfulness, the IRS considers your knowledge of the unpaid taxes and the actions you took.
The IRS considers whether you were just following orders, but that's not always an effective defense.
There are a lot of grey areas - that's why you need an expert by your side.

TFRP assessments can be extremely scary - these penalties can be huge, and once the penalty is assessed, the IRS can go after all of your personal assets. If you're facing a potential TFRP, it's critical to understand the definition of willfulness and how it applies to this penalty.

It's even more important to work with a tax professional who understands this nuances of this concept - using TaxCure, you can search for pros who have experience representing clients facing TFRP assessment.

How does the IRS define willfulness?

For the purposes of the TFRP, the IRS defines willfulness as a voluntary, conscious, and intentional act. A person acts willfully when they intentionally allow payroll taxes to go unpaid - they didn't need to have malicious intent or a plan to evade taxes.

When determining if a responsible person acted willful, the IRS looks at their intent, purpose, and knowledge. There is case precedent to support this definition.

For instance, in the U.S. Supreme Court case United States v. Cheek, the court held that "the standard for the statutory willfulness requirement is the voluntary, intentional violation of a known legal duty." Known duty means that the taxpayer needs to know about the requirement to pay the tax.

However, it's important to note that claiming a lack of knowledge is generally not a sufficient defense for the TFRP. The IRS also considers cases of willful blindness, where you should have known about the law or the unpaid taxes, but you willfully decided to be blind to the situation.

Willfulness is not just a standard in TFRP assessment. It's also a factor in the following:

Examples of willful conduct

Let's take a look at willfulness in action. Here are scenarios where the IRS is very likely to see an individual as acting willfully:

Knowingly paying other bills instead of the payroll taxes: For instance, paying rent, utilities, vendors, salaries, or even owner draws instead of payroll taxes. However, this standard generally applies to the person who makes the decision to pay the other bills, not to an individual who initiates the payments based on a superior's directions.
Directing subordinates not to pay payroll taxes: As indicated above, the person who makes the decision not to pay the taxes, is acting willfully, even if they don't make the payment personally but direct someone else to do it.
Using personal funds for unnecessary expenses instead of paying payroll taxes: For example, someone who inherits money that they could use to cover their business's payroll taxes, but instead, they spend it on a vacation while continuing to operate the business with unpaid taxes.
Continuing operations knowing payroll taxes aren't being paid: When you withhold funds from an employees' paycheck, you hold that money in trust before sending it to the government. If you don't pay those taxes but continue to pay other operational expenses, the IRS sees that as a willful decision - in fact, this can often be a reason for the IRS to deny a request for an installment agreement on payroll taxes.

In some cases, the IRS may even decide that there was criminal intent, and they may refer the case to the Criminal Investigation department. If you're worried about potential criminal exposure related to unpaid payroll taxes and the TFRP, contact a criminal tax attorney as soon as possible.

Examples of non-willful conduct

So, what's non-willful conduct? The IRS generally defines nonwillful as inadvertent actions or honest mistakes. Generally, if someone acted in good faith, they are not considered to have acted willfully.

Here are some situations where the IRS may determine that a responsible person did not act willfully:

Lack of knowledge - You were genuinely unaware that payroll taxes weren't being paid, and you had no reason to know. For instance, you're a partner or shareholder who isn't involved in the day-to-day operations of the business and with limited or no access to the company's accounts.
Lack of authority - You may have been involved in not paying the payroll taxes, but you were acting under a superior's directions. You did not have the authority to make this decision, nor were you consulted.
Following orders - Generally, as implied above, if you did not have the authority to make the decision, you will not be held responsible because you were following orders. However, this defense doesn't always hold up - for instance, if you are a licensed tax professional who knew the decision to pay other bills over payroll taxes was illegal, the IRS may consider that you acted willfully.
Accidental errors - If a simple bookkeeping error lead to the unpaid taxes, the IRS may decide that you did not act willfully. However, this can be a hard argument to make - by the time the IRS starts thinking about assessing the TFRP, they have notified the business about the unpaid payroll taxes several times, giving them ample opportunity to fix errors.

Unfortunately, claiming that you didn't know about the requirement to pay withhold taxes will generally not hold up in most cases. The courts have adopted a definition of willfulness that includes recklessnesses. Claiming that you didn't know about payroll taxes when you own a business or are actively involved in a business's finances generally constitutes recklessness.

Murky Gray Areas: Where Willfulness Becomes Debatable

As outlined above, willfulness can be a grey area, and certain scenarios make it even murkier than usual. Here are some situations where you and the IRS may define willfulness differently:

Relying on Professional Advice - If you reasonably relied on a professional's advice, you may not have acted willfully, but ultimately, it boils down to whether or not your reliance on them was reasonable. In other words, would other entrepreneurs acted in the same way? Should you have done more due diligence?
Delegating responsibilities - You may be able to argue that you delegated this responsibility to another person and that you weren't aware that they weren't paying the taxes. However, the IRS will closely examine whether or not you should have noticed the lack of payment and what your oversight was and should have been.
Uncertainty about tax rules - If you acted in good faith and had a reasonable interpretation of the law, you can argue that you weren't wilful. However, as stated throughout this post, the IRS doesn't often accept the argument of ignorance about payroll taxes.
Taking over a financially distressed company - When buying a company, you should ensure that their payroll liabilities are cleared before the purchase, but that doesn't always happen. If you inherited a business with unpaid payroll taxes, the IRS may accept this argument that you weren't willful, but they will look closely at which actions you took since taking over the company.
Acting under coercion - The IRS may determine that you were unwillfully if you were coerced into taking an action. However, if you argue that you were pressured to not pay these bills by your partners, the IRS may explain that you acted willfully. There's a difference between pressure and coercion.

The fact that the distinction between willful and nonwillful gets so murky underscores the importance of having experienced representation by your side. You need a tax pro who understands these arguments so they can put forward the best defense possible to help you avoid a TFRP assessment.

What if someone advised you not to pay withholding taxes?

Outside pressure or advice doesn't necessarily absolve you from willfulness. You have to show that it was reasonable to rely on that advice. If you were pressured into not paying the taxes, you may need to explain what you thought would have happened if you didn't follow those orders - for instance, would your employer have fired you? Or were they abusive to you?

Although outside advice is not always an acceptable defense in a TFRP assessment case, it can be useful information. Let your tax pro know this when you hire them. Also, gather proof of any advice you received - for instance, emails or text messages from your accountant.

What if the IRS thinks you might be responsible?

If the IRS identifies as a potential responsible person for the purposes of the TFRP, they'll contact you and ask to set up a Form 4180 interview. During the interview, the revenue officer will try to determine if you're a responsible person and if you acted willfully. If the IRS determines that both of these elements are true, they will send you Letter 1153 along with Form 2751, proposing a TFRP against you.

At that point, you can agree with the assessment and pay it. Or, you can request an additional meeting with the revenue officer, ask for mediation, or appeal the penalty. If appeals is not successful, the IRS will assess the penalty and move forward with collections.

Find expert tax help today.

The TFRP is one of the IRS's worst penalties, and once it's assessed, your options for relief can be quite limited. Don't wait. Protect your peace of mind and your assets by reaching out for help now. Start your search now and use the filters to narrow down your results to find pros who have experience representing clients facing a TFRP assessment.