If you own or manage a business with employees, there’s a harsh tax penalty that you could be at risk for paying personally. The Trust Fund Recovery Penalty (TFRP) applies to Social Security and income taxes that are withheld by a business from its employees’ wages.

Sweeping penalty

The TFRP is dangerous because it applies to a broad range of actions and a wide range of people involved in a business.

Here are some answers to questions about the penalty:

What actions are penalized? The TFRP applies to any willful failure to collect, or truthfully account for, and pay over taxes required to be withheld from employees’ wages.

Why is it so harsh? Taxes are considered the government’s property. The IRS explains that Social Security and income taxes “are called trust fund taxes because you actually hold the employee’s money in trust until you make a federal tax deposit in that amount.”

The penalty is sometimes called the “100% penalty” because the person found liable is personally penalized 100% of the taxes due. The amounts the IRS seeks are usually substantial, and the IRS aggressively enforces the penalty.

Who’s at risk? The penalty can be imposed on anyone “responsible” for collecting and paying tax. This has been broadly defined to include a corporation’s officers, directors and shareholders, a partnership’s partners and any employee with related duties. In some circumstances, voluntary board members of tax-exempt organizations have been subject to this penalty. In other cases, responsibility has been extended to professional advisors and family members close to the business.

According to the IRS, responsibility is a matter of status, duty and authority. Anyone with the power to see that taxes are (or aren’t) paid may be responsible. There’s often more than one responsible person in a business, but each is at risk for the entire penalty. You may not be directly involved with the payroll tax withholding process in your business. But if you learn of a failure to pay withheld taxes and have the power to pay them, you become responsible. Although taxpayers held liable can sue other responsible people for contributions, this action must be taken entirely on their own after the TFRP is paid.

What’s considered willful? There doesn’t have to be an overt intent to evade taxes. Simply paying bills or obtaining supplies instead of paying over-withheld taxes is willful behavior. And just because you delegate responsibilities to someone else doesn’t necessarily mean you’re off the hook. Failing to do the job yourself can be treated as willful.

Recent cases

Here are two cases that illustrate the risks.

1.    A U.S. Appeals Court held a hospital administrator liable for the TFRP. The administrator was responsible for payroll and signing and reviewing checks. She also knew that the financially troubled hospital wasn’t paying withheld taxes to the IRS. Instead of prioritizing paying taxes, she paid vendors and employees’ wages. (Cashaw, CA 5, 5/31/23)

2.    A corporation owner’s daughter/corporate officer was assessed a $680,472 TFRP for unpaid payroll taxes. She argued that she wasn’t a responsible party. She owned no stock and couldn’t hire and fire employees. But she did have the power to write checks and pay vendors and was aware of the unpaid taxes. A U.S. Appeals Court found the “great weight of evidence” indicated she was a responsible party, and the TFRP was upheld. (Scott, CA 11, 10/31/22)

Best advice

Under no circumstances should you “borrow” from withheld amounts. All funds withheld should be paid over to the government on time. Contact us with any questions.