To encourage prompt payment of withheld income and other employment taxes, Congress passed legislation allowing certain business owners and control persons to be held personally liable for these taxes.
Taxes that are withheld from employees or third parties are referred to as trust fund taxes. The transfer of these taxes from the business to responsible corporate individuals is known as the trust fund recovery penalty. Within the federal tax system, individuals can be held personally responsible for withholding taxes, social security taxes and certain excise taxes. The law authorizing these transfers is found in §6672 of the Internal Revenue Code.
For state taxes, individuals can also be held responsible for unpaid sales tax.
According to the Internal Revenue Code, the trust fund transfer penalty may be assessed against any person who is responsible for collecting or paying withheld taxes and who willfully fails to collect or pay. Thus there is a three part test to determine whether someone may be personally liable for unpaid taxes.
First, the trust fund transfer penalty laws applies only to trust fund taxes. Unpaid corporate income tax is not a trust fund. It is not money that has been collected from a third party. Income withheld and not paid to an employee is a trust fund tax just as the sales tax collected from a new car buyer.
Next, the individual must be responsible for collecting or paying these taxes. The IRS has successfully transfered taxes to owners, officers, directors and even bookkeepers. The key is who actually has the authority or duty to collect or pay. Titles alone are not enough to hold a person responsible (although frequently that is the only information known to the IRS).
For the third prong, willfullness, the law looks to see if the responsible person was aware or should have been aware of the unpaid taxes and either intentionally or recklessly failed to pay them. No evil intent or bad motive is required.
Many business owners and managers think they are shielded by state laws that protect business owners from personal liability of corporate debts. These laws, however, do not apply to unpaid trust fund taxes.
Even a business bankruptcy can’t protect responsible corporate officials.
The IRS is not limited to collecting from or assessing one person. They can assess as many people as they wish as long as each individual meets the tests above.
If the IRS does assess the trust fund recovery penalty to multiple parties, they can collect from just one, some or all of the responsible individuals. The IRS tends to go after the person with the most assets and simply lets that person seek contribution after the fact from others. This is called joint and several liability.
What does this mean to you? If you own or run a business and have some say in what bills are paid, you could be held responsible for unpaid withholding taxes, social security and Medicare assessments. If the business owes state sales taxes, you could be held responsible for those as well.
Remember that neither the IRS nor state tax authorities are required to chase everyone or collect an equal amount from each responsible person. If you have the big bank account, expect the IRS to try and collect the entire penalty from you.
What happens if you are assessed these penalties and do not pay? The IRS can take collection action against you just as if you did not pay your personal taxes. Liens, levies and wage garnishment are all possibilities. Even criminal prosecution.
Think you can file bankruptcy to get rid of these trust fund taxes? Think again. Unlike personal income taxes, Congress and the IRS have made it difficult to avoid payment of trust fund taxes.
There is hope in all this. The IRS frequently does not have an accurate understanding of job functions and responsibilities in most businesses. They frequently know who signs returns. But return or check signing authority or titles alone are not enough. The key is responsibility and control. The vice president of finance, for example, might have no authority to pay taxes. The bookkeeper may sign checks and returns but simply upon orders from someone higher in the business.
Just because the IRS says you personally owe the taxes for the business does not make its so. Trust Fund Recovery Penalty assessments are often overturned. The key is good documentation and a painting a clear picture of who is responsible.
Unpaid trust fund penalty cases usually arise when the business is struggling to pay bills. The owners may divert the payroll taxes to pay non-IRS creditors instead. The individuals who made the decision to divert the money can be held personally liable for the unpaid payroll tax debts.
There is more hope. The Internal Revenue Manual says that the trust fund penalty “will normally not be assessed when the likelihood of successful collection is minimal.” Sometimes you can convince the IRS that the penalty is not readily collectible or is more easily collected from a different party.
The IRS generally has three years to assess the trust fund recovery penalty. Assessments are usually investigated by the IRS Collection Division. Frequently the IRS will demand to examine other tax records, organization charts, bank records, signature cards, articles of incorporation, shareholder agreements, bylaws, canceled checks, corporate minutes, and corporate resolutions to establish the responsibility and willfulness elements needed for assessment.
Revenue Officers will also attempt to interview individuals who may have knowledge of the entity’s decision making processes and financial condition. Revenue Officers will then attempt to conduct a Form 4180 interviews with those individuals who may have had a role in diverting the money. These interviews are designed to elicit admissions to support that a Section 6672 assessment is warranted. If the investigation has reached this far, competent legal counsel is strongly suggested.
If the Revenue Officer’s recommendation for assessing a trust fund recovery penalty is approved, a 60-day letter is issued to those taxpayers that were deemed responsible for failing to pay the money. The 60-day letter notifies them of the proposed assessment. After receiving a 60-day letter, a taxpayer may dispute the penalty prior to it being assessment (pre-assessment appeal) or after it has been assessed (post-assessment appeal). A key difference between the two options is that interest will not accrue if the appeal is made before the penalty is assessed. If a taxpayer does not provide a response within the required 60 days, the IRS will assess the trust fund recovery penalty and the IRS will begin to pursue collection efforts against that taxpayer.