Trust Fund Recovery Penalty

The trust fund recovery penalty, often called the TFRP, is an IRS penalty that can reach you personally even when the tax was owed by a business. It applies to people who were responsible for collecting and paying over payroll withholding and who willfully failed to do so. Because it can be assessed against owners, officers and others, and collected from personal assets, it deserves attention the moment an employer falls behind on payroll taxes.

Why it is called a trust fund

Withheld income tax and employee Social Security and Medicare tax are not the employer's money. The employer holds them in trust for the government until a deposit is made. The TFRP exists to encourage prompt payment of those amounts. It can apply when the trust fund taxes cannot be collected right away from the business, and the business does not have to have closed. The IRS also uses it for certain collected excise taxes.

The employer's own share of payroll taxes is not part of the trust fund amount. The penalty is measured by the employee-side withholding that was not paid over.

Who is a responsible person

A responsible person has the duty and the power to direct the collecting, accounting for and paying of trust fund taxes. The IRS says this can include:

• officers or employees of a corporation
• partners or members of a partnership
• directors or shareholders
• board members of a nonprofit
• anyone with authority over which bills are paid
• certain third-party payers and responsible parties at professional employer organizations

Title alone does not settle it. The question is whether the person exercised independent judgment over the business's finances. An employee who only paid bills as directed by a superior, without deciding which creditors were paid, is not a responsible person. The IRS may ask for an interview to understand each person's duties.

What willful means

Willful here does not require evil intent. The person must have known, or should have known, about the unpaid taxes and either intentionally disregarded the law or been plainly indifferent to it. Using available funds to pay other creditors, such as suppliers or rent, when payroll taxes were due is a typical sign of willfulness, according to the IRS.

How the penalty is calculated

The penalty amount is the unpaid balance of the trust fund tax. The IRS manual describes it as equal to the total tax not collected or not paid over, and Pub. 15 describes it as 100% of unpaid trust fund taxes.

Example (hypothetical). A company withheld $30,000 of income tax and employee Social Security and Medicare tax over two quarters but deposited only $10,000. The unpaid trust fund amount is $20,000. A responsible person assessed the penalty owes $20,000, plus interest. If two responsible people are assessed, the IRS can collect the full $20,000 from either of them, but only $20,000 in total.

The process

1. The IRS investigates. A revenue officer may interview people about who controlled the money and who signed checks.
2. A letter proposes the assessment. The IRM calls it Letter 1153. It states the proposed amount and your appeal rights. The 60-day period (75 days outside the United States) runs from the date of the letter.
3. You choose to agree, appeal or do nothing. If you do not respond, the IRS assesses the penalty and sends a notice and demand for payment.
4. Collection. After assessment, the IRS can collect from your personal assets, including liens and levies. See IRS liens and levies.

Treat the 60 days as a hard deadline. An appeal is a written protest sent to the IRS, and the letter explains the address and what to include. Publication 5 describes the appeals process.

Defending a proposed assessment

The usual questions are whether you were responsible, whether you acted willfully, and whether the amount is right. Evidence includes bank signature cards, who hired and fired, who could approve payments, who prepared and signed the returns, and when you learned of the shortfall. Each of those can be contested. A title such as owner or officer does not by itself settle responsibility or willfulness, so each point is worth answering with records.

If the business can pay, paying the trust fund taxes reduces what remains. A business tax debt can also be addressed through an installment agreement or other collection options. A power of attorney lets a representative speak with the revenue officer for you.

How to avoid it

• Deposit withheld taxes on time. A late deposit carries its own failure-to-deposit penalty, and deposits that stay unpaid can lead to this one.
• Do not use withheld taxes to pay other bills, even briefly. The IRS counts that as a sign of willfulness.
• If you use a payroll service, verify that the deposits were actually made. Using a provider does not remove the responsibility.
• Keep payroll tax payments ahead of other creditors when cash is tight, and call the IRS early if you cannot pay.

How we can help

We can review the facts about your role, gather records for the interview or protest, and prepare the written appeal before the deadline. We also help employers set up deposit controls so a shortfall does not occur. We cannot predict whether the IRS will assess or drop the penalty. For questions about personal legal exposure, a tax attorney may also be appropriate.

See our payroll services, the guide to payroll tax penalties and relief, and contact us.

Frequently asked questions

General information only, not tax, legal or accounting advice for your situation. Rules, limits and deadlines change; confirm the current rules with the official source or a qualified professional before you act. Reading this page does not create a professional relationship with CPA Tax Payroll and Accounting Corp.