IRS Trust Fund Recovery Penalty – 3 Reasons Why It Can Be “Scary”

The IRS Trust Fund Recovery Penaltyfile0001597709523-thumb-375x280-49365

The Phrase sounds scary and complex. In theory, it isn’t that complex. It can be scary though and especially for the small business owner who is struggling to make a profit each month.

First…Why it isn’t that complex

The basic idea behind the penalty is that Congress wanted to encourage businesses to send in the portion of income, social security and Medicare tax withheld from employee’s paychecks.

So it passed a few laws.

First, it made this tax a “Trust Fund Tax”

Internal Revenue Code 7501 says that whenever any person is the one required to collect any internal revenue tax from any other person and to make sure that it is paid to the US Government, that amount withheld is to be held in “Trust” i.e. it is a “trust fund tax”.

This means that the money shouldn’t be mixed in with other money the business earns while waiting for it’s trip to the Government Bean Counting Room.

Than, it made the Trust Fund Tax one that is owed by the business AND the people responsible for the books at the business.

Internal Revenue Code 6672(a) says that any person who is required to collect or account for this trust fund tax and who doesn’t pay it can become liable for the amount of the trust fund personally.

A few things to take from the above:

1. If you are responsible for collecting and paying the tax (most small business owners meet this requirement because there isn’t anyone else to do it)


2. If the failure to pay the tax was willful.. i.e. you paid other creditors when you knew the payroll tax hadn’t been paid or you just disregarded the problem after being warned by staff.

This penalty can be assessed against you.

For the small business owner, the theory behind the penalty isn’t that complex but the result of it can be scary…for three reasons.

1. You Become Personally Responsible

If you are a responsible party and the action was willful you will personally owe the debt. Not just the business. This can happen even if you don’t own the company.

2. The Debt Can Be Very Large

If the business has 10 employees and those 10 employees are each paid $3500.00 per month on average and assuming an overall tax on the employee paycheck of 10% for income, social security and Medicare…that equals about $10500.00 per quarter.

Fail to pay this for one year’s worth of quarters and the penalty can be as high as $42000.00

3. The Penalty Isn’t dis-chargeable in Bankruptcy

Never. Bankruptcy won’t help in relation to getting rid of the debt.

You have challenge the proposed assessment. If that doesn’t work, you have to try to get the IRS to take less in an offer in compromise. If that doesn’t work, pay it on a monthly basis potentially for a long time.


If you work somewhere that isn’t paying the tax collected from employees, or if you are a small business owner struggling to pay the tax as you go, do what you need to do to get the books in order and to start paying it.

We can help. We are able to review the history of your income and expenses and find ways to stop the bleeding so that the tax can start being paid.

Trust Fund Recovery Penalty: Responsible for making sure payroll tax gets paid by the business? You need to be aware of this.

Congress passed a law a long time ago that was meant to “encourage” employers to pay the income and fine pic-thumb-375x249-49354employment tax (social security and medicare) they collect from employees’ paychecks. This law provides for a penalty to be assessed if the tax collected isn’t paid. That penalty is called an IRS Trust Fund Recovery Penalty. It is often called the 100% penalty as well.

The tax that is collected from the employee’s paycheck is considered “trust fund” tax because the employer holds the tax in trust until the deposit is made to the IRS. If you are an employer, you are 100% liable for the amount that is collected.

Internal Revenue Code 7501 makes clear that whenever any person is required to collect any internal revenue taxes from any other person and to pay over such tax to the United States, the amount of the tax shall be held in a special trust fund for the United States.

If the person responsible to do so doesn’t forward the trust fund tax, the IRS can use the law passed by congress to penalize him or her for 100% of the Trust Amount. It won’t matter that the business is still operating.

Internal Revenue Code 6672(a) provides:

“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 on 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 most common assessments of the trust fund recovery penalty come from the
following taxes:

• 941, Employer’s Quarterly Federal Tax Return – most common
• 720, Quarterly Federal Excise Tax Return
• 944, Employer’s Annual Federal Tax Return
• 945, Annual Return of Withheld Federal Income Tax

The penalty is not based on 940 Unemployment Taxes.

The 941 penalty amounts are made up of the employee’s income tax and fica tax withheld form his or her paycheck. It doesn’t include the employer’s matching portion.

The Statute says…The 100% penalty can be assessed against you if:

1. you “willfully” fail to collect or pay the trust fund tax and if you are;
2. a person who is “responsible” for collecting and paying it.

Courts usually look at the following to determine whether you are a “Responsible Party”:

a. What were your duties
b. Did you have the ability to sign checks
c. What was the Identity of officers and shareholders
d. Who was the person(s) responsible for hiring and firing
e. Who was in charge of the financial affairs of the business

“Willfulness” is often shown by:

a. Paying other creditors after you know the withheld monies haven’t been paid to the IRS.
b. You recklessly disregard the risk that the taxes aren’t being paid.

In essence, even if you didn’t have actual knowledge that the taxes weren’t being paid, you can be assessed the penalty just because you disregarded what was going on. Being negligent isn’t enough but choosing not to investigate after finding out they weren’t being paid?

Most of our clients are small business people and as a result it is difficult for them to defend the allegation that they were responsible and willful.

It is often wise when the assessment is being considered by the IRS to talk to an attorney about other options you may have to avoid it or to deal with it once assessed. The IRS offer in compromise can play a big role in both avoiding the assessment and in reducing the amount of the assessment after the fact.
Look at newer blog entries for more about this penalty.