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Updated IRS guidance explains who is on the hook for trust fund recovery penalty

Employment Taxes and the Trust Fund Recovery Penalty (TFRP).

Notice 784, Could You be Personally Liable for Certain Unpaid Federal Taxes?

IRS has updated its webpage guidance on the trust fund recovery penalty and who IRS can reach to pay it. The guidance is a reminder for all potential “responsible persons” to make sure that timely payment of employment taxes is given the highest priority at any profit or nonprofit enterprise.

Background on trust fund recovery penalty. Code Sec. 6672 imposes the trust fund recovery penalty (also known as the 100% penalty) on any person who: (1) is responsible for collecting, accounting for, and paying over payroll taxes; and (2) willfully fails to perform this responsibility. It’s called the trust fund recovery penalty because responsible persons are treated as holding the withheld tax in trust until there’s a federal tax deposit of the amount. The amount of the penalty is equal to the amount of the tax that was not collected and paid.

What does “willfully” mean? According to IRS (as well as the courts), “willfully” means voluntarily, consciously, and intentionally. A responsible person acts willfully if he knows that the required actions are not taking place. Paying other business expenses, including paying net payroll, instead of paying trust fund taxes, is considered willful behavior.

IRS also says that for willfulness to exist, the responsible person:

…must have been, or should have been, aware of the outstanding taxes; and
…either intentionally disregarded the law or was plainly indifferent to its requirements (no evil intent or bad motive is required).

Who is a responsible person? 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.

According to IRS, this person may be:

  • An officer or an employee of a corporation.
  • A member or employee of a partnership.
  • RIA observation: In Rev Rul 2004-41, 2004-18 IRB, IRS concluded that LLC members may be liable for the unpaid employment taxes under the Code Sec. 6672 trust fund recovery penalty rules.
  • A corporate director or shareholder.
  • A member of a board of trustees of a nonprofit organization.
  • RIA observation: Code Sec. 6672(e) may provide taxpayers relief in certain cases. It provides that unpaid volunteer board members of tax-exempt organizations who are solely serving in an honorary capacity, aren’t involved in day-to-day financial activities, and don’t know about the penalized failure are exempt from the penalty, unless that results in no one being liable for it.
  • Another person with authority and control over funds to direct their disbursement. This may include accountants, trustees in bankruptcy, banks, insurance companies, or sureties. It even may include another corporation.
  • RIA observation: For example, in Erwin v. U.S., (DC NC 02/05/2013) 111 AFTR 2d 2013-748111 AFTR 2d 2013-748, a district court held that two outside accountants were each liable for over $325,000 in trust fund recovery penalties due to their failure to remit a financially troubled client’s unpaid withholding taxes to IRS. Even though the accountants were not officers or directors of the client, it was clear that they had substantial control over the client’s payroll operations.
  • Another corporation or third party payer.
  • Payroll Service Providers (PSPs) or responsible parties within a PSP.
  • Professional Employer Organizations (PEOs) or responsible parties within a PEO.
  • Responsible parties within the common law employer (client of PSP/PEO).

New rules in place for PEOs. Small businesses often contract with PEOs, also known as employee leasing companies, to ensure compliance with workplace laws and regs. In the typical contract, the PEO computes the FICA, withholding tax, worker’s compensation, and 401(k) contributions of each employee and bills the client for the amount. The contract requires the PEO to pay the employees and make the clients’ tax deposits. Some PEOs file their client companies’ employment tax returns under the PEO’s name and list the PEO as the employer of the client companies’ employees. Under the law that existed before the Tax Increase Prevention Act of 2014 (TIPA), when a business contracted with a PEO to administer its payroll functions, the business customer remained responsible for all withholding taxes with respect to its employees. Thus, even though the PEO paid the employees, the customer remained liable if the PEO failed to withhold or remit the taxes or otherwise comply with related reporting requirements.

However, effective for wages for services performed on or after Jan. 1, 2016, Code Sec. 3511, as added by TIPA, allows a “certified PEO” (CPEO) to, in certain circumstances, be treated as the sole employer of the employees. Earlier this month, IRS issued proposed reliance regs that define terms and provide details as to the operations and responsibilities of CPEOs. (T.D. 9768, Weekly Alert ¶  28  05/12/2016) IRS also issued proposed reliance regs that set out the Federal employment tax liabilities and other obligations of persons certified by the IRS as CPEOs. (Preamble to Prop Reg05/04/2016, Weekly Alert ¶  31  05/12/2016)

Assessing the trust fund recovery penalty. If IRS determines that a person is a responsible person, it will inform him of its plan to assess the trust fund recovery penalty. The person then has 60 days (75 days if this letter is addressed to a person outside the U. S.) from the date of this letter to appeal. A nonresponse will result in the assessment of the penalty and trigger an IRS Notice and Demand for Payment. Once IRS asserts the penalty, it can take collection action against the taxpayer’s personal assets. For instance, it can file a federal tax lien or take levy or seizure action.

References: For trust fund recovery (100%) penalty for responsible person’s failure to collect, account for, and pay over tax, see FTC 2d/FIN ¶  V-1700  ; United States Tax Reporter ¶  66,724  ; TaxDesk ¶  864,001  ; TG ¶  71655  .