Trust Fund Recovery Penalty Explained by a CPA

If you have employees, you know — or you should know — that you are responsible to withhold certain taxes from their paychecks.  At the federal level, these taxes typically include:

• Federal income tax withholding
• Employee’s share of Social Security tax withholding
• Employee’s share of Medicare tax withholding

Since this money is not your money — it’s your employees’ money that they earned but that must be paid to the government to cover their tax liability on their wages — but as their employer you are required to collect this money and remit it to the government, this money is considered to be held by you “in trust” until you remit it and these taxes are therefore referred to as “trust fund taxes.”

And the IRS takes it very seriously if you or your company keep this money that your employees earned that needs to be paid to the government for their taxes and, rather than sending it to the government, you or your company use it for other purposes.

The IRS essentially views this as stealing from the federal government — and when it comes to the federal income tax withholding piece, they view it as stealing from them twice.

Think about it.  In a normal situation, let’s say that a business withholds $2,000 in federal income taxes from one of their employees and remits it to the government.  The employee goes to file their tax return, and — just in this very simple example to illustrate a point — let’s say the employee is supposed to get that $2,000 back as a refund.  OK, that’s fine from the IRS’s perspective — they got that $2,000 over the course of the year as the employee was working, and now they’re giving it back to the employee because it turns out the employee doesn’t own those taxes anyway.

But here’s the kicker when businesses fail to remit employees’ federal income tax withholding to the government — the government can’t hold it against the employee that its employer dropped the ball.  So think of the situation now — not only has the IRS not received that $2,000 in federal income tax withholding for that employee, but because they can’t hold that against the employee, they also have to write the employee a $2,000 check when the employee goes to file their return.  So in the case of unremitted federal income tax withholding, the government is out the money twice — once because it doesn’t actually get the cash deposited into the Treasury and twice because when the employee goes to file their tax return the government has to give them credit for that $2,000 whether it actually made its way into the Treasury or not.

So because the government takes this very seriously, it is permitted to assesses a penalty against any “responsible person” — and I’ll talk more in this article about who is a “responsible person” when it comes to trust fund taxes — in the amount of 100% of these trust fund taxes that the business failed to remit; this is the trust fund recovery penalty.

What Is the Trust Fund Recovery Penalty?

The trust fund recovery penalty is a penalty assessed by the IRS against “responsible persons” who fail to collect or remit trust fund taxes to the federal government.

• Acronym: TFRP

The trust fund recovery is distinct from the business’s actual payroll tax liability in the following two ways:

• The payroll tax liability is the business’s obligation, while the trust fund recovery penalty is assessed against responsible persons.
• The payroll tax liability includes all payroll taxes the business failed to remit to the government — including both the employer’s and employees’ share of such taxes — while the trust fund recovery only include the employees’ share, i.e., the trust fund taxes.

How Much Is the Trust Fund Recovery Penalty?

The trust fund recovery penalty is a penalty equal to 100% of the federal taxes an employer withholds from its employees’ paychecks — the “trust fund taxes” — that it does not remit to the government.

Who Can Be Assessed the Trust Fund Recovery Penalty?

The IRS can assess a trust fund recovery penalty against anyone whom it believes to be a “responsible person” who was responsible to collect, account for, and remit trust fund taxes to the federal government but who willfully failed to do so.  Both the responsibility and the willfulness must exist.

And it can assess the trust fund recovery penalty for the same trust fund taxes against multiple responsible persons who then become jointly and severally liable — just like a married couple who files a joint tax return — for the debt.

That means that each responsible party is personally liable for the entire debt.  Of course, if the debt is paid off by one or multiple parties, then that settles the matter for everyone at that point; the aggregate amount of trust fund recovery penalty collected by the IRS cannot exceed the unpaid trust fund taxes because the trust fund recovery penalty is simply a mirrored assessment of the unpaid trust fund taxes at the entity level.  If those unpaid trust fund taxes are paid by the business or if they are satisfied by another responsible person as a trust fund recovery penalty or some combination of the two, that’s it; everyone’s off the hook at that point.

That said, the IRS is known to be extremely aggressive when it comes to determining who is and who isn’t a responsible person when it comes to the trust fund recovery penalty.

You don’t have to necessarily own a business that failed to remit its employees’ withholdings to the government in order to be assessed the trust fund recovery penalty.

Who Is a “Responsible Person”?

The statute allows for an assessment of the trust fund recovery against anybody who is “required to collect, truthfully account for, and pay over” a trust fund tax; this is what the IRS considers a “responsible person” for trust fund recovery penalty purposes.

Yes, this could be the owner of the company, but it could also be another individual with signature authority on the company accounts.

It could be a company treasurer, controller or even a bookkeeper.

In fact, the IRS website says that those who are responsible for “accounting for” or “depositing” trust fund taxes could be a responsible person when it comes to the trust fund recovery penalty.

On another page, the IRS gives a bit longer list of potential targets for the trust fund recovery penalty:

• Officers
• Employees
• Members
• Corporate directors
• Board members of a nonprofit organization
• Anybody with authority and control over funds to direct their disbursement
• Third-party payers
• Payroll service providers
• Professional employer organizations
• Responsible parties within the common law employer

That said, in order for an individual to be considered “responsible” for these purposes, they must not merely have been acting at the direction of someone else, such as a supervisor or boss; they must have exercised some degree of “independent judgment” resulting in the trust fund taxes not being properly remitted.  This does not necessarily mean that they had to have “final say” or “ultimate responsibility” over the non-remittance of the trust fund taxes, but they must have had some power regarding whether or not the payroll taxes were remitted.

And for our trust fund recovery penalty cases at Choice Tax Relief, sometimes we fight the IRS and make arguments that our client did not have the power to make these kinds of decisions regarding whether or not the payroll taxes were paid.

For example, maybe a company has a bookkeeper, and for the convenience of the boss, the bookkeeper has signature authority on the company’s bank account, meaning that the bookkeeper can write and sign company checks.

And on that basis, the IRS may come in and try to claim that this bookkeeper is a “responsible person” for trust fund recovery penalty purposes.

But what if the process for paying bills at the company was for the bookkeeper to write and sign all the checks and then go meet with their boss, who tells the bookkeeper which bills to pay.

In this instance, we would argue that the bookkeeper really didn’t have the power to pay the payroll taxes; sure, they may write and sign checks, but really they’re just going to do what their boss tells them; they are simply fulfilling a clerical function without any real power to make the decision as to whether the payroll taxes got paid or not.

What Does It Mean to Be “Willful”?

The fact that an individual was a responsible person is not enough for the IRS to assess the trust fund recovery penalty; the responsible person must also have willfully failed to remit the tax.

But what does it mean to be “willful”?

In this context, it means that both of the following things are true:

1. The responsible person was aware or should have been aware of the outstanding trust fund taxes.
2. The responsible person either intentionally disregarded the requirement to remit the trust fund taxes or was merely indifferent to this requirement.

Note that an evil motive — e.g., to embezzle the money rather than paying it to the government — is not required.

In fact, a business owner or other responsible person may think they’re doing the right thing — or at least the less bad thing — by not remitting the trust fund taxes in order to pay some other business expense.

For example, if a business owner has to choose between paying their contractors or remitting the trust fund taxes, they may figure that paying their contractors is more important since they don’t want their contractors to starve.  “I’ll pay my guys now and pay the government later; Uncle Sam has enough money anyway.”

Unfortunately, taking an action like this — paying other business expenses with the trust fund taxes money that should have been remitted to the government — is a clear indication of willful failure to remit the taxes.

Can a Sole Proprietor Be Assessed the Trust Fund Recovery Penalty?

Whether or not a sole proprietor can be assessed the trust fund recovery penalty depends on if the proprietor has a single-member LLC or not.

Sole Proprietor Without a Single-Member LLC

A sole proprietor without a single-member LLC cannot be assessed the trust fund recovery penalty.

This is because there is no need for the IRS to assess the trust fund recovery penalty against a sole proprietor without a single-member LLC. This is because the sole proprietor is already personally liable for all unpaid payroll taxes, trust fund or not.

The trust fund recovery penalty exists to make a “responsible person” personally liable for business payroll tax debt, but a sole proprietor without a single-member LLC is already liable for all of his sole proprietor’s unpaid payroll taxes, so there is no reason for the IRS to assess the trust fund recovery penalty against a sole proprietor.

Sole Proprietor With a Single-Member LLC

A sole proprietor with a single-member LLC can be assessed the trust fund recovery penalty.

This is because although the LLC is disregarded for federal income tax purposes (insofar as it has not elected to be taxed as a corporation), it is a regarded entity for payroll tax purposes, meaning that only the LLC is liable for any past-due payroll taxes.

In this case, then, the IRS would have an incentive to assess the trust fund recovery penalty against the sole member of the LLC, and it often does in such cases.

How the IRS Assesses the Trust Fund Recovery Penalty

Once the IRS discovers that a company’s trust fund taxes have not been paid in, it typically launches an investigation into whom it can assess the penalty against.

But how does the IRS even suspect in the first place that a company’s trust fund taxes haven’t been paid in?  The process starts with a Federal Tax Deposit (FTD) Alert.

FTD Alerts

The IRS’s FTD Alert Program identifies anomalies in employer’s payroll tax deposit history and patterns to determine the employers who have missed their payroll deposit requirement and are least likely to self-correct their payroll deposit requirement.

This analysis is typically done in the twelfth week of each quarter, and these alerts are sent out to revenue officer groups the following week, so the thirteenth week of each quarter.  So this process generally happens during the last month of the quarter, which is March for Q1, June for Q2, September for Q3, and December for Q4.

So the revenue officer group manager gets these FTD Alerts, which they are supposed to assign to a revenue officer in their group within seven calendar days.  And then once a revenue officer is assigned the alert, they are supposed to review the business’s payroll history and contact the employer or their representative about their payroll issues and even visit the place of business within 15 calendar days.  (Yes, they are supposed to visit the business location — they want to see what’s going on!)

And sometimes the result after the revenue officer talks things over with the business or its representative is that there was an anomaly with the employer’s payroll deposits because the business actually isn’t liable for payroll taxes anymore because they laid off a lot of people or maybe the business is seasonal, which would explain the drop in payroll deposits.  And in these cases, the revenue officer would close the FTD Alert with the appropriate closing code:

But what if the business really has fallen behind on their payroll taxes?  In this case, the revenue officer will attempt to compel the business to get in compliance with their payroll obligations.  They will usually discuss the following issues with the business:

• The failure-to-deposit penalty
• The notice of federal tax lien
• Possible levy and seizure actions
• The trust fund recovery penalty

If the business then gets in compliance — filing all required Forms 941 and paying the payroll taxes, penalties, and interest it owes — all is well, and the case will be closed.

But if the business does not get in filing and payment compliance, the IRS may take collection activity against the business and even file SFR 941 returns for any unfiled payroll tax returns.

And that stuff — how the IRS can collect from the business entity itself — is a separate conversation for another day.  But of course something else the IRS can do at this point once it’s determined that the business is out of compliance with its payroll obligation is to assess the trust fund recovery penalty against responsible persons.  And that’s what we’re talking about today.

And step one in this process of assessing the trust fund recovery penalty against responsible persons is for the IRS to determine who these responsible persons are, and that process begins with doing trust fund penalty interviews.

Trust Fund Penalty Interviews

Trust fund penalty interviews are typically either done in person or by phone.

In these interviews, the interviewer — generally, the IRS revenue officer — asks the interviewee, who is suspected of possibly being a responsible person, questions derived from IRS Form 4180 “Report of Interview with Individual Relative to Trust Fund Recovery Penalty”.

The purpose of this interview is to determine whether the interviewed person is both responsible and willful for the unpaid trust fund taxes.

On this form, the individual being interviewed is asked about their responsibilities for the business that failed to remit the trust fund taxes — they are asked specific questions concerning their job and its responsibilities.

The Importance of Fighting the TFRP

Once the IRS finds a taxpayer to be a “responsible person” for purposes of the trust fund recovery penalty, the taxpayer has 60 days to protest.

A recent Tax Court case, Kazmi v. Commissioner, reflects the importance of protesting a trust fund recovery penalty.

In this case, the IRS assessed a trust fund recovery penalty against one Mohammad A. Kazmi for trust fund taxes that his employer, Urgent Care Center, Inc., failed to remit for the second and third quarters of 2014.

But Mohammad was a mere bookkeeper doing what he was told; nevertheless, because he did not properly protest the assessment, he is still liable for it today (along with others).

The Form 4180 Interview

The way the IRS determines if someone is a “responsible person” is by conducting a Form 4180 Interview.

This interview is typically done by a revenue officer, who will likely want to do it in person (or over the phone, according to the Internal Revenue Manual); they typically won’t just accepted a completed Form 4180 from the taxpayer or their representative.

Now, the taxpayer can refuse to do the interview if they don’t think they have any good defenses anyway.

On the Form 4180, the IRS is looking for information to find others responsible as well as the interviewee.

Note that this Form 4180 is not very friendly to the taxpayer; it asks several “Yes/No” questions, but doesn’t really give space for the taxpayer to qualify their answers to these “Yes/No” questions.

However, what we do for our clients is prepare our own Form 4180 with little written explanations in the little space we have next to the “Yes/No” and mail copies of our version to both the revenue officer and their group manager with a request for them to memorialize this copy of the Form 4180, which contains our client’s complete answers to the questions rather than partial “Yes/No” answers.

For example, one question on Form 4180 is, “Did you authorize or make Federal Tax Deposits?” Well, what if someone is a clerical bookkeeper who can make Federal Tax Deposits (at the discretion of their boss) but couldn’t necessarily authorize them (because that was something reserved for the boss)? They’d still just have to answer, “Yes,” to this question.

What To Do If You’ve Been Assessed the Trust Fund Recovery Penalty

If you’ve been assessed the trust fund recovery penalty, you have some options:

1. Request from the IRS the names of other responsible persons as well as what the IRS has done to attempt to collect the trust fund recovery penalty from these individuals — this is your statutory right under Internal Revenue Code Section 6103(e)(9).
2. Contest the penalty itself.
3. Seek contribution from other responsible persons.

History of the Trust Fund Recovery Penalty

Although not referred to by that name, the trust fund recovery penalty has been a part of American tax law for almost a century; it was originally codified in Section 2707 of the Internal Revenue Code of 1939, which is the precursor to today’s Internal Revenue Code Section 6672.

Trust Fund Recovery Penalty FAQs

Here are some common questions relating to the trust fund recovery penalty.

Do employees still get credit even if their employers fail to remit trust fund taxes on their behalf?

Yes, employees still get credit, even if their employer did not pay in to the IRS the federal income tax, Social Security tax, or Medicare tax it withheld from their paychecks.

How long does the IRS have to assess the trust fund recovery penalty?

The general statute of limitations on assessment — how long the IRS has to assess a liability against a taxpayer — is three years. There are exceptions to this that make it six years or even unlimited, but the general statute is three years.

And it is no different with the trust fund recovery penalty.

The question, of course, is, “Three years from when?”

And here’s the answer:

The IRS has three years from the later of the April 15 following the quarter in question or the actual date the payroll tax return was filed to assess the trust fund recovery penalty.

The three years does not start ticking from the actual quarterly due dates for the 941s; the due date for trust fund recovery penalty statute of limitations purposes is the April 15 following the year for the quarters in question.

So let’s say the IRS is looking to assess the trust fund recovery penalty for unpaid trust fund taxes for Q1 2024; and let’s say that Form 941 for Q1 2024 is due April 30, 2024. The statute of limitations for the trust fund recovery penalty is not April 30, 2027; it is April 15, 2028, which is three years after the April 15 after the quarter in question.

But what if the taxpayer filed their payroll tax return late? What if they filed their Q1 2024 Form 941 on August 4 — that’s my birthday — 2025? Then the IRS would have until August 4, 2028, to assess the trust fund recovery penalty for that quarter.

Now, what if the 941 is never filed? In this case, the statute never starts running, and the IRS can prepare an SFR for the 941, and they can assess the trust fund recovery penalty whenever they want — in this case when no 941 is filed, the statute never starts running.

The statute can be extended if you sign Form 2750; there are other instances where the statute can be extended; but the general rule is that the IRS has three years from the later of the April 15 following the quarter in question or the actual date the payroll tax return was filed to assess the trust fund recovery penalty.

Now, the statute of limitations on collections after the trust fund recovery has been assessed is 10 years as I discuss in the video below.

If the IRS assesses the trust fund recovery penalty against five different responsible persons, can it theoretically collect five times the trust fund taxes due?

No, the IRS can never collect through trust fund recovery penalty more than the unpaid trust fund taxes that the business failed to remit.

What is the trust fund recovery penalty statute of limitations?

Once assessed, the trust fund recovery penalty statute of limitations on collections is 10 years — the same as other IRS assessments.

But what about the statute of limitations on assessment, that is, how long does the IRS have to assess the trust fund recovery penalty?

The IRS has three years from the later of the April 15 of the year following the quarter in question or the actual filing date of the Form 941.

If the 941 was never filed, then the statute of limitations on assessment of the trust fund recovery penalty never starts running and the IRS can assess it at any time (though it would have to prepare 941 SFRs first).

Can you do an offer in compromise for the trust fund recovery penalty?

Yes, you can submit an offer in compromise to settle your trust fund recovery penalty for less than you owe.

Author:

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Logan Allec, CPA, Founder and Owner

Logan Allec has been serving taxpayers as a CPA for over 14 years. After leaving his role at a "Big 4" firm, he started Choice Tax Relief to help everyday Americans who have found themselves behind on their taxes. He also educates thousands of people daily about tax relief on his YouTube channel. In addition to his CPA license, Logan also has a Master's Degree in Taxation from the University of Southern California (USC). He lives with his wife and children in the Los Angeles area. Learn more about Logan here.

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