The Trust Fund Penalty: When Business Debts Become Personal
The trust fund recovery penalty is the IRS's most effective tool for collecting unpaid employment taxes. The penalty allows the IRS to collect business taxes from the responsible corporate officers or employees. This article explains your options for dealing with this penalty.
About Withholding TaxesOur tax law requires businesses to withhold taxes from employee paychecks. This includes Federal income tax and Social Security contributions.
These withheld taxes are then held *in trust* for the IRS. There is no requirement that the funds be segregated into a trust or separate fund or account. Rather, the funds can be kept in the business* general bank accounts and then remitted to the IRS quarterly.
Businesses often use these funds as a ready source of cash. In effect, businesses that fail to remit withholding taxes are getting a loan from the IRS without the IRS*s consent.
Our tax laws provide for civil and criminal penalties in these types of cases. The trust fund penalty is a civil penalty that can apply.
The Trust Fund PenaltyThe trust fund penalty is set out in Sec. 6672, which says:
"Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over."
The penalty is equal to the amount of the unpaid withholding taxes. The penalty can be assessed against more than one individual, as explained below. Once assessed, the penalty can be collected in the same manner as the underlying taxes.
Who is the Responsible Person?The penalty does not apply to the business that failed to withhold taxes. It applies to the officers or employees who were *responsible persons* with respect to the taxes. Responsible persons include individuals who were (1) "responsible for effectuating the collection and payment of trust-fund taxes" but who (2) "willfully fail[ed] to do so."
The IRS often takes the position that anyone with check writing ability or who actually wrote checks is the responsible person. The courts look to whether the person had the *effective power* to pay the taxes.
What is Willful?The IRS has the burden to prove that an individual is a responsible person. Once it has done that, the individual has to disprove the willful element. Willfulness requires only a *voluntary, conscious, and intentional act, not a bad motive or evil intent."
It is proven by showing that the individual knew of the unpaid withholding taxes and then the individual used the business* funds to pay creditors other than the IRS. It can also be proven by showing that the individual acted with reckless disregard.