January 31, 2023
How Can Business Owners Avoid Liability for the IRS’ Trust Fund Recovery Penalty (TFRP)?
When companies collect payroll taxes from their employees, they hold their employees’ funds “in trust” pending remittance to the IRS. When companies fail to timely remit their employees’ funds held in trust, they can face substantial liability—including liability for the IRS’ trust fund recovery penalty (TFRP).
While the IRS often seeks to impose the TFRP against companies that have gone out of business without remitting funds held in trust, the IRS makes clear that “[a] business does not have to have stopped operating in order for the TFRP to be assessed.” As the IRS also notes, individuals who are responsible for a company’s failure to remit taxes held in trust can face liability as well.
Liability for the Trust Fund Recovery Penalty (TFRP)
In Notice 784, the IRS explains when companies and responsible individuals can face liability for the TFRP. Specifically, it identifies four scenarios in which the penalty may apply:
- Failure to collect trust fund taxes
- Failure to truthfully account for trust fund taxes
- Failure to remit trust fund taxes to the IRS when due
- Evading or defeating trust fund tax liability in any other way
As noted above, both companies and responsible individuals can face liability for the TFRP. A responsible individual is any person who “[i]s responsible for collecting or paying withheld income and employment taxes, or for paying collected excise taxes,” and who “[w]illfully fails to collect or pay them.” Depending on a company’s organizational structure and the specific circumstances involved, this could potentially include:
- Company owners
- Officers and directors
- Accounting and payroll department personnel
- Employees of third-party payroll service providers
The IRS considers an individual’s failure to remit trust fund taxes to be willful when the individual (i) “[m]ust have been, or should have been, aware of the outstanding taxes” and (ii) “[e]ither intentionally disregarded the law or was plainly indifferent to its requirements.” If a failure to remit trust fund taxes is deemed to be non-willful, then the TFRP does not apply—though the company is still liable for its outstanding tax liability as well as interest and any other associated penalties.
Avoiding Liability for the TFRP
Before imposing the Trust Fund Recovery Penalty, the IRS will send a letter expressing its intent to assess the penalty. Companies and individuals in the United States then have 60 days to fight the imposition of the TFRP (those located outside of the U.S. have 75 days). As the IRS explains, “If you do not respond to our letter, we will assess the penalty against you and send you a Notice and Demand for Payment.” While it may be possible to file an appeal once the TFRP has been imposed, it is best to avoid the penalty when possible. Once the IRS imposes the TFRP, it is due and payable, and the IRS can take collection action including filing tax liens and initiating seizures against both companies and individuals.
Companies and individuals can challenge the imposition of the TFRP in several ways. In many cases, one of the most effective ways is to challenge the IRS’s evidence of willfulness. As discussed above, if the IRS cannot prove that the failure to remit trust fund taxes was willful, it cannot impose the TFRP. Individuals can also seek to avoid liability by challenging the IRS’s assertion that they were a “responsible person” based on their role within the company, and companies and individuals alike can avoid liability by disputing the IRS’ allegations that they have failed to remit trust fund taxes when due.
Avoiding Liability for Other Employment Tax-Related Penalties
While the IRS has the authority to impose the TFRP directly, failure to remit trust fund taxes and other employment-tax-related violations can also lead to other penalties through criminal prosecution. IRS Criminal Investigation (IRS CI) regularly targets companies and individuals for these violations, and those suspected of violating the law can face prosecution by the U.S. Department of Justice (DOJ).
With this in mind, upon receiving a letter from the IRS stating its intent to impose the TFRP, companies and individuals should work with their tax counsel to evaluate their other risks as well. If an alleged trust fund tax violation has the potential to lead to criminal tax charges, it will be important to promptly formulate a comprehensive and cohesive defense strategy. For those that are already under investigation for employment tax fraud, mitigating the risk of prosecution will involve:
- Intervening in IRS CI’s investigation
- Discerning the full scope of the allegations at issue
- Conducting an internal audit to assess the validity of the allegations at issue
- Identifying all viable defenses and formulating a defense strategy
- Working to resolve the investigation without a referral to the DOJ
How Much is the TFRP (and What Are the Potential Criminal Penalties)?
For employment taxes, the TFRP is calculated based on the amount of the unpaid balance owed. This includes both withheld income taxes and withheld FICA taxes. There is no cap on the amount of the Trust Fund Recovery Penalty.
When charged with criminal tax law violations, companies and individuals can face substantial additional financial liability. For individuals, federal prison time is a risk as well. Under the federal tax evasion statute, 26 U.S.C. Section 7201, willfully attempting to evade or defeat any federal tax is a felony offense punishable by a fine of up to $500,000 for companies and up to $100,000 and five years of federal imprisonment for individuals. Allegations of criminal tax fraud can also lead to other charges that carry similar penalties.
Speak with a Tax Lawyer at Brown Tax, P.C. in Fort Worth, Texas
If you need to speak with a lawyer about avoiding the Trust Fund Recovery Penalty (and/or other penalties for federal employment tax fraud), we encourage you to contact us promptly for more information. To speak with a tax lawyer at Brown Tax, P.C. in Fort Worth, Texas as soon as possible, please call 888-870-0025 or tell us how we can reach you online now.