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  • Robert Nath

Trust Fund Recovery Penalty

Updated: Mar 14, 2022

What is the “trust fund recovery penalty?”

It’s not a true penalty but only a substitute for part of the payroll taxes that an employer fails to pay over to the IRS. The employer is required to withhold income tax and FICA/Medicare from employee’s wages, and then pay these over by Federal Tax Deposit. The law imposes a trust on these withheld funds. When the employer fails to pay these over, the law imposes personal liability on anyone “responsible” for the employer’s failure to pay over the withheld taxes. By this means the IRS hopes to “recover” the “trust fund” portion taxes not paid over. (The employer-paid FICA/Medicare is not withheld; therefore, there is no personal liability for this part.) This personal liability is not avoided by state law protections of limited liability normally available for corporate debts.

How does the IRS investigate this penalty?

The IRS computers monitor the tax filings of all employers. The system checks to determine whether the employer filed a return (usually, Form 941) and paid the tax. When there is a failure, the computers issue notices to the employer. If the employer fails to respond by filing/paying, the IRS can assign an agent to investigate. The agent will also investigate the employer for its obligation and also the “responsible persons” at the same time. If the corporation pays in full, no one is investigated for the trust fund. But short of that, the investigation will go forward. The agent will gather information on who had financial authority inside the company, and who knew about the taxes. Then the agent will make a formal written proposal of liability against one or more “responsible persons.” This can be appealed and even taken to court.

If someone else pays the trust fund penalty, do I get credit too?

Yes, dollar for dollar. The corporation also gets credit (since it’s a corporate liability). However, the IRS will apply those trust fund dollars first to the trust fund portion of the company’s taxes, leaving the employer’s portion of FICA/Medicare potentially still unpaid. If the corporation also pays to the IRS, you can get credit for those payments against your personal assessment if the corporation “designates” the payments to “trust fund” or if it pays more than the employer’s portion only.

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