IRS Trust Fund Recovery Penalty: What it is and How to Settle

trust fund recovery penalty

When you have employees, you withhold their Medicare and Social Security contributions from their checks, and in most cases, you also withhold some income tax. These amounts are referred to as trust fund taxes, and you are obligated to send that money to the IRS.

If you fail to make those payments, the government can charge a very serious penalty called the Trust Fund Recovery Penalty.

What is the Trust Fund Recovery Penalty (TFRP)?

The Trust Fund Recovery Penalty is the penalty you face if you withhold income tax, Medicare, and Social Security payments from your employees’ paychecks, but you don’t send the money to the IRS. It is one of the largest penalties charged by the IRS. The agency takes it very seriously, and if you are deemed responsible for the missing payments, the IRS will not hesitate to take your personal assets to recoup their money. IRC 6672 provides the authority for the TFRP. It is a penalty imposed on individuals who are obligated to collect, account for, and remit taxes held in trust but they knowingly fail to fulfill these duties or intentionally attempt to dodge or prevent paying the taxes.

 

Who Can Be Responsible for the TFRP?

The IRS can and will levy this penalty on anyone who willfully fails to collect and pay trust fund taxes. That includes owners, CEOs, and directors, but it can also include employees, third-party payroll administrators, outside accountants, and bookkeepers. For corporations, shareholders can also be held responsible, and for non-profits, members of the board of trustees may be considered responsible.

Essentially, anyone in the organization who collects or pays these taxes can be held responsible. In addition, anyone who knows the taxes are not being paid can also be held responsible. The IRS can hold multiple people responsible, and the agency will do what it takes to get the money.

To establish responsibility, the IRS has to prove that the individual in question was aware that the taxes were due and aware they weren’t being paid. The individual must have purposefully or willfully ignored the law. For example, if you or someone related to your organization took the money set outside for payroll and income taxes and used it to pay another bill, that’s a clear sign of willfulness.

What to Do If the IRS Thinks You're Liable for Your Employer's Trust Fund Recovery Penalty?

Employees and third parties who handle payroll need to be careful. If the IRS decides that you are responsible for these unpaid taxes, you can face serious penalties and even criminal charges. Check out this link to learn what to do if the IRS is threatening to hold you liable for your employer's or client's trust fund taxes.

How Much Is the Trust Fund Recovery Penalty Amount?

The Tax Fund Recovery Penalty is not small. In fact, it is equal to the amount of taxes that were unpaid. Once again, that includes any income taxes withheld from an employee’s paycheck plus the employee’s Social Security and Medicare contributions. Note that Social Security and Medicare contributions are also referred to as FICA (Federal Insurance Contributions Act) taxes. Any payments that were timely or designated as being for trust fund taxes only will be subtracted. 

To explain, let’s say you paid an employee $1,000. You noted on the paycheck stub that you withheld $100 for income tax plus $62 for Social Security and $14.50 for Medicare. However, you didn’t send any of that money to the IRS. In that case, the unpaid tax bill is $176.50. You owe that amount plus that amount again as a penalty. That doubles your bill.

With a single employee, that can be a lot over an extended period of time. With multiple employees, the numbers can be staggering.

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

If the IRS believes that a company hasn’t been paying its trust fund taxes, an officer from the agency starts an assessment to figure out who is responsible. As part of that process, the IRS requests multiple documents and lots of information from the company.

That includes bank statements and canceled checks, but it also includes details about who has passwords for online accounts and who knows PINs for bank cards. The IRS wants to see who’s paying the bills, who controls the money, and where the money is going.

The agency will likely also request articles of incorporation or partnership contracts to get a sense of the layout of power in the company. Then, when the agent hones in on a potentially responsible party or parties, the IRS will request an interview with those people.

What Is the Interview for a Trust Fund Recovery Penalty?

There’s a lot to understand about the interview process. Whether you are the owner of a company or just someone the IRS thinks is responsible for the missing taxes, you may be summoned. You might be required to complete a Form 4180 interview., to assess the full extent of your job duties and responsibilities. The IRS will determine responsibility based on whether an individual exercised independent judgment with regard to the business finances. If an employee simply pays creditors directed by their manager or boss, they generally won't be held responsible. Click the links for detailed information on the interview process and how to avoid an interview.

How Can You Settle the Penalty?

Like other types of tax liabilities, there are options to pay this penalty. If you don’t have the full payment, you can apply for a payment plan or an installment agreement. Alternatively, you can try to settle the taxes owed for less than you owe through the Offer in Compromise program or through a partial payment installment agreement.

The important thing is to contact the IRS and set up an arrangement before the IRS tries to garnish your wages or seize your assets. You cannot discharge these penalties in bankruptcy.

What Are Non-Trust Fund Taxes?

To get a better understanding of trust-fund taxes, you should understand non-trust fund taxes. Trust fund taxes have that name because employees trust their employers to send the funds to the government on their behalf. Basically, employers are supposed to keep that money in a trust fund until they send it to the IRS. They are not supposed to do anything with the funds.

However, there are also non-trust fund taxes. In particular, employers must match their employees’ Social Security and Medicare contributions. Those matching amounts are considered non-trust fund taxes.

The IRS typically only holds the business responsible for non-trust fund taxes. It does not hold individuals responsible. However, the exact liability rules depend on your business structure. If you’re self-employed or the sole principal of an LLC, you may be held personally responsible for both trust-fund and non-trust fund taxes.

 

What Forms Are Involved in the Tax Fund Recovery Penalty?

If the IRS thinks you are responsible, you will receive Letter 1153. This comes with Form 2751. If you sign this form, you are admitting liability. Follow the link for more information on these forms and what to expect.

What Is the Statute of Limitations on the Trust Fund Recovery Penalty?

If the IRS assesses a penalty, it has up to 10 years to collect it. During that time, the IRS will take your assets if you are responsible.

However, the IRS only has 3 years to assess the penalty. This clock starts ticking on April 15 after the year the trust fund taxes were due to be filed. For instance, let’s say a company was supposed to pay some trust fund taxes in October 2016. The IRS has three years from April 15, 2017 to assess the penalty. If the IRS doesn’t do anything by April 14, 2020, it can’t do anything After that date, it’s illegal for the IRS to investigate or conduct interviews. 

This is the statute of limitations for auditing payroll tax returns as well. However, it's important to note that there are exceptions to this rule. For instance, if you don't file a return, the clock doesn't start for the statute of limitations. Additionally, the IRS also extended the statute of limitations for certain employer returns that claim the employee retention tax credit. In other words, you may face an ERC audit after the typical deadline, and if the IRS disallows your claim, it may levy penalties on your account. 

Help with the Trust Fund Recovery Penalty & TaxCure

Here at TaxCure we have compiled a network of tax professionals from around the country with a wide variety of backgrounds resolving various tax problems. We have a unique ranking algorithm that can help taxpayers find the best professionals to help with particular tax problems. To see the top-rated professionals that can help with trust fund recovery penalties, visit this link here. You can see their backgrounds and reach out to them with details on your situation to get more information on how they can help you.

Find & Evaluate Licensed Tax Professionals to Solve Your Tax Issues

Select Tax Agency/Agencies

Find & Evaluate Licensed Tax Professionals to Solve Your Tax Issues

Select Tax Agency/Agencies