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You probably are familiar with an employer’s obligation to withhold payroll taxes from each employee’s wages and submit these funds to the IRS on a regular basis. When a company fails to do so, it is subject to unsparing IRS penalties and is on the hook to satisfy the unpaid payroll tax as well as any penalties associated with nonpayment.
Many taxpayers are surprised to learn, however, that in some situations business owners, officers, employees, and individual third parties can be held personally responsible for a portion of the company’s payroll tax that goes unpaid. This means that the IRS can go after the personal assets of certain individuals when the employer drops the ball on making its payroll deposits and/or fails to file its quarterly federal tax return.
This article explains the fundamentals of payroll tax and explores the circumstances under which an individual can be held personally responsible for a portion of the unpaid payroll tax of an employer or company, including a discussion of the amount of tax that is attributable to the individual and the process by which the IRS makes this assessment.
Payroll Tax Basics
All employers are required by law to withhold payroll taxes from their W-2 employees’ wages and to remit same to the IRS along with other amounts paid directly by the employer via regular deposits and reporting using Form 941 Employer’s Quarterly Federal Tax Return.
The first part of the payroll tax relates to funds withheld from an employee’s wages and consists of:
- Federal income tax withholding as per the W-4;
- The employee’s portion of the Medicare tax; and
- The employee’s portion of the Social Security tax.
This portion of the payroll tax is also referred to as the trust fund given that the employer is required to hold the funds in trust until depositing them with the IRS.
The second part of the payroll tax represents the employer’s matching share as required by the Federal Contributions Insurance Act (FICA). FICA requires that the employer match the Social Security and Medicare taxes that were withheld from the employee’s pay. These funds are contributed by the employer separately and included in the quarterly deposit.
Trust Fund Recovery Penalty Assessment
If a business fails to remit their payroll taxes, the IRS can assess personal responsibility against certain individuals. In this section, we discuss who can be held responsible, for how much, and by what process.
Who Can Be Held Responsible?
Owners, executives, officers, employees, directors, shareholders, and third parties such as payroll service administrators can be held personally responsible for a portion of the company’s payroll taxes via a trust fund recovery penalty assessment. In such case, the IRS can seize the personal assets of the individual to satisfy the unpaid payroll taxes of the business.
Pursuant to Internal Revenue Code 6672, personal liability will be assessed if the IRS determines that the individual is responsible for collecting and paying payroll taxes and they willfully fail to collect or pay the payroll taxes.
A “responsible person” will have significant control or influence over the company’s finances. Circumstances that may give rise to a finding of sufficient control and influence include the following:
- Control over business payroll;
- Authority to make federal payroll deposits;
- Check signing authority;
- Authority to prepare, review or sign payroll tax returns;
- Hiring or firing authority;
- Job title;
- Ownership interest.
In order to qualify for willful evasion, the responsible person must have i) known that the taxes payroll taxes were due for remittance (or should have known) and ii) either intentionally disregarded the law or remained indifferent to its requirements (without any showing of intent).
For example, if a responsible person uses company funds to pay a bill when those funds could have been applied toward payroll taxes, that will satisfy the willfulness element. On the other hand, an employee who is directed to make payments on behalf of the company will not be deemed a responsible person.
How Much is the Trust Fund Recovery Penalty?
The trust fund recovery penalty is equal to funds that the employer withheld from the employee’s wages; namely the unpaid income taxes and the employee’s portion of the Social Security and Medicare tax.
Notably, the employer’s matching portion of the FICA tax is not included in the trust fund recovery penalty. This means that any responsible person will only be liable for the portion of the payroll tax that was withheld from the employees’ wages. Typically, this represents 65% of the overall payroll tax liability.
The trust fund recovery penalty is a joint and several liability as between the employer and the individual, meaning that it is not a double tax of the same amount but shared by both parties. The IRS can pursue collection of the trust fund recovery penalty against either the employer, the individual or both.
How is the Trust Fund Recovery Penalty Assessed?
The IRS may conduct an interview, known as the Trust Fund Recovery Penalty Interview to determine the full scope of a person’s duties and responsibilities within the company. In this situation, a Revenue Officer will request to conduct an interview based on IRS Form 4180 Report of Interview with Individual Relative to Trust Fund Recovery Penalty. The agent will ask a series of questions designed to reveal how the individual may have been involved in the company’s finances and payroll.
If the IRS determines that you are a responsible person, it will send Letter 1153 and Form 2751 Proposed Assessment of Trust Fund Recovery Penalty to which you can respond by signing Form 2751 to agree to the assessment or appeal the proposed assessment and notify the IRS. Taxpayers typically have 60 days from the date of the notice to respond.
You can sometimes avoid the 4180 interview altogether in the following situations:
- If you agree to the assessment of the trust fund recovery penalty;
- If the total payroll tax is less than $25,000 and the business establishes a direct debit installment agreement to repay the liability in full in two years or less; or
- If you can demonstrate that you don’t have the ability to pay the tax if it were to get assessed. This will involve the completion of a financial statement with supporting documentation to substantiate your financial circumstances.
Of course, the best way to avoid the TFRP is to ensure that all employment taxes are collected and paid to the IRS when required.
Do You Need a Tax Attorney?
A tax attorney can help you resolve the outstanding payroll tax liabilities of your business and also advise respective business owners, company officers, and employees with respect to their exposure to a possible trust fund recovery penalty assessment. You may need legal advice with respect to handling a 4180 interview and resolution of trust fund recovery penalties.
The experienced tax attorneys at Segal, Cohen & Landis have helped clients navigate payroll tax issues successfully by providing the following services:
- Counsel on exposure to trust fund recovery penalty assessment;
- Determination if the statute of limitations for collection of unpaid payroll taxes has expired or will soon;
- Representation through 4180 interview;
- Submit an offer in compromise to reduce the amount of trust fund recovery penalties;
- Secure short-term deferment of payroll tax;
- Negotiate an installment agreement with the IRS to repay the payroll taxes over a period of years;
- Establish not collectible status;
- Evaluate the tax savings of shutting down the business, changing entity structure, or reorganizing;
- Secure a release of tax levy and/or tax lien to free up business assets and obtain funding for the purpose of repaying the payroll tax debt.
If you are interested in having a complimentary consultation with one of our partner attorneys regarding your tax matter, please feel free to contact us at 866-505-1872. We would be happy to advise you as to how we can resolve your case and how much it would cost.