Understanding Back Payroll Taxes and Trust Fund Penalty

Employers are regularly required to pay over to, or deposit with, certain designated depository institutions the amounts withheld from their employees (i.e., the federal income tax and the employee’s portion of FICA) plus the employer’s portion of the FICA. The frequency of the required deposits is dictated by the amount of employment taxes incurred during certain periods. The frequency of deposit may be as short as one business day and as long as quarterly.

Filing Requirements and Deposit Schedules

In addition, a business’ FUTA liability must normally be deposited by the end of the month following a calendar quarter.

Non-agricultural employers are required to file a Form 941 (Employer’s Quarterly Federal Tax Return) on a quarterly basis. The Form 941 return is due on or before the last day of the month following the close of each calendar quarter (thus, by April 30, July 31, October 31, and January 31). The Form 941 reports the quarterly gross wages paid, the federal income tax withheld, the sum of the employer’s and employees’ FICA liability and the deposits paid. Any taxes still owing after the deposits are accounted for must be paid with the return.

Consequences of Nonpayment and Trust Fund Penalty

Often, a financial crisis occurs, and management makes the decision to use the employment tax deposit money to pay a threatening supplier or creditor, instead of making the required deposit. Businesses confronted with financial or cash-flow difficulties often perceive creditors other than the Service as being more important. In the early stages of the cash crunch, the Service is nowhere to be seen while other creditors have already terminated the extension of further credit and are currently demanding payment for goods and services. The typical response is one of eternal optimism, and the business owner often uses the employment tax deposits to pay threatening creditors, while planning to pay the IRS when a large outstanding receivable comes in. At some point, that large receivable doesn’t come in, and the game of paying past employment taxes with current revenue comes crashing down. The snowball is suddenly rolling with unstoppable size and speed. The nonpayment is “pyramiding,” one quarter on top of the other.

Personal Liability for Trust Fund Taxes

Sole proprietors become directly liable for these unpaid taxes. However, prior to the enactment of Section 6672, the IRS had no effective way to collect the unpaid taxes of separate entities such as corporations and LLCs. The owners would simply “walk away” from the entity and unpaid taxes would basically die with the entity. In response, Section 6672 was enacted to pursue parties who were responsible for paying the taxes, but for whatever reason didn’t.

Regardless whether the Service is also attempting to collect the unpaid taxes from the business as the primary obligor, section 6672 empowers the Service to collect the unpaid Trust Fund tax liabilities of corporations and other types of limited liability entities from the personal assets of those persons who were responsible for the nonpayment of the taxes. In effect, the statute enables the Service to “pierce the veil of limited liability” and hold many individuals secondarily or vicariously liable. For any particular “Trust Fund” deficiency, several persons may be held jointly and severally liable.

Since more than one person can be found liable and in order to enlarge the pool of personal assets from which the underlying tax may be collected, the Service often asserts the penalty against everyone who might be liable under the statute. Outside the business, the officers and other responsible persons must be concerned with personal liability for the trust fund taxes under the provisions of section 6672.

Determining Liability and Interviews with the IRS

Ultimately, however, in order for an individual to be liable under section 6672, it must be determined that (1) the individual was a “responsible person” (someone who has the status, duty and authority over the financial decision making) and (2) the individual “willfully” failed to collect, truthfully account for, and pay over “Trust Fund” taxes (by knowingly allowing other creditors to be paid while the trust fund taxes were due the Service). The absence of either removes liability.

An IRS Revenue Officer will attempt to personally interview all individuals who might have knowledge of:

(1) how decisions were made within the organization,

(2) who had decision-making authority to control which creditors were paid, and

(3) who was familiar with the company’s financial condition and the status of outstanding tax debts

In conducting interviews, the Revenue Officer will question potential targets by completing an interview form. It is very important to have a tax attorney for this interview. What is said during this interview will determine whether the taxpayer will be personally liable for the employment taxes owed by the company. You DO NOT have to be an owner, or a person that had substantial power within the organization to be hit with a Trust Fund Penalty. Many taxpayers give unclear answers during the initial interview in regards to their duties and responsibilities, and end up paying part of the employment taxes for a company they currently or used to work for.

Protesting a Trust Fund Penalty Assessment

In small cases, a formal protest is not required. The taxpayer’s representative merely needs to write a letter requesting a conference with the Appeals Office and identifying with which issues in the 60-day letter he disagrees and why. In order to properly protest a trust fund penalty assessment when the amount at issue is greater than $25,000, counsel needs to complete a formal written protest. In preparation for filing the protest and meeting with an Appeals Officer, counsel should obtain all records, documents, and files from the taxpayer, the Service and third parties relative to the taxpayer, the business and the investigation of the penalty. Thoughtful legal analysis is also critical. There are literally hundreds of cases in this area, each very fact specific.

Next Steps and Potential Consequences

If the Appeals Officer and the taxpayer do not reach agreement, Appeals will send the case forward. If the case was in 60-day status, it will be sent to the Service Center, where the tax will be assessed. If the case was already in collection and the taxpayer previously filed a refund claim or Offer in Compromise, the file will be returned to the Collection Division for further collection activity. Tax Court review is not available, so a properly crafted appeal is important. Any further review can only be obtained in federal court at much greater expense.

It must be stressed at this point, that the business will still remain liable for the unpaid employment taxes, as well as any parties assessed the Trust Fund Penalty. The IRS will only collect the amount owed once, so technically, whoever pays first will end up potentially paying the share of the other parties. The IRS tends to follow the path of least resistance to recover these penalties. And as mentioned before, if the business was a sole proprietorship, there will be no trust fund penalty and the taxpayer will be directly liable for the taxes owed.

Get Help with Back Payroll Taxes and Trust Fund Penalty

If you are having employment tax issues, or are at risk of being assessed a Trust Fund Penalty, call Insight Law at 206-922-8078 or fill out this online form to set up a free consultation. Employment taxes can snowball rather quickly and bury a business and its owners due to penalties and interest. The rules for employment taxes vary somewhat from the rules for income taxes. Having a creative tax attorney is a must.