Are You Risking the Trust Fund Penalty for Unpaid Payroll Taxes?

Are You Risking the Trust Fund Penalty for Unpaid Payroll Taxes?
The trust fund penalty is one of the more onerous tax provisions on the books. In short, a company owner or officer, or another “responsible person,” may be held personally liable for any unpaid payroll taxes. Because the assessment is for 100% of the tax due, this provision is sometimes called the “100% penalty.”

The IRS is allowed to pursue more than one person for this tax obligation. In a recent Third Circuit Court of Appeals case, USA v. Darren Commander, the court imposed the trust fund penalty against a corporate co-owner even though it was the other owner who was responsible for payroll. The U.S. Supreme Court has declined to review the appeals court’s decision, so the decision stands.

Who’s Responsible

Can You Settle with the IRS?

As with other types of tax debt, taxpayers who owe the trust fund penalty have options. For instance, if you can’t pay the full amount owed, you may apply for a payment plan or installment agreement. Alternatively, you can try to settle the debt for less than you owe through the “offer-in-compromise” program or a partial payment installment agreement.

The most important thing is to contact the IRS and set up an arrangement before the agency tries to garnish your wages or seize your assets. You can’t discharge those penalties in bankruptcy.

The trust fund penalty may be assessed against any person who:

  1. Is responsible for collecting or paying withheld income and employment taxes or for paying collected excise taxes, and
  2. Willfully fails to collect or pay those taxes.

Typically, this liability is imposed on a company owner or president, but it potentially could extend down the ranks to a mid-level manager or bookkeeper.

Notably, a responsible person for these purposes is any person — or group of people — who has the duty to perform and the power to direct the collecting, accounting and paying of trust fund taxes. Accordingly, the IRS says this could be:

  • An officer or employee of a corporation,
  • A member or employee of a partnership,
  • A corporate director or shareholder,
  • A board of trustees member of a not-for-profit organization,
  • Someone with authority and control over funds to direct their disbursement,
  • Another corporation or third-party payer,
  • Payroll Service Providers (PSP) or responsible parties within a PSP,
  • Professional Employer Organizations (PEO) or responsible parties within a PEO, or
  • Responsible parties within the common law employer (PSP/PEO client).

The IRS broadly interprets “willful failure.” The failure doesn’t have to be intentional. For example, the trust fund penalty may be applied in situations where someone knew, or should have known, about the taxes that should have been paid, but weren’t. In other words, the penalty may be imposed on someone regardless of their intentions.

Summary Judgment

In Darren Commander, a trial court granted summary judgment against a 50% owner of a woodwork fabrication and installation business.

He and his co-owner (who died during the court proceedings) formed the woodworking company in New Jersey in 2003. They were the sole officers and owners. All decisions and actions, as well as most significant financial transactions, could only be made with the consent of both parties. However, the other co-owner was responsible for hiring field employees, assigning employees to each job, ensuring work was completed in the field, recording hours worked and distributing paychecks to employees.

From 2007 through 2009, the company failed to pay income and employment taxes for its employees even though workers were being paid. The IRS imposed trust fund penalties totaling $1.6 million against the defendant in 2010.

The trial court granted summary judgment to the government. It concluded that there is no factual dispute that the defendant was a responsible person who willfully failed to pay the company’s taxes. In support of this decision, the court noted that:

  • The defendant was a 50% owner and one of two officers of the company.
  • His approval was required for all company decisions and actions and many significant financial transactions, and
  • He had check-signing authority and power to pay the company’s bills and sign paychecks.

The defendant argued that his co-owner was solely responsible for paying the taxes. But the court found this to be irrelevant because the defendant was, in fact, a responsible person. The court concluded that the defendant had actual knowledge, or should have known, that the taxes weren’t being paid and that he acted willfully within the meaning of the trust fund penalty provision.

The appeals court rejected the defendant’s arguments and upheld the trial court’s grant of summary judgment for the government. Critical to the court’s decision: Liability for the trust fund penalty can be extended to more than one person.

The appeals court also dismissed the defendant’s claim that he had originally misspoken in saying that he was aware of the tax deficiencies during the tax years in question and actually learned of it “later.” The court determined that the defendant didn’t produce any evidence to substantiate this assertion. Finally, it disagreed with the defendant’s complaint that he wasn’t granted sufficient opportunity to prove his arguments.

The defendant appealed the Third Circuit’s decision to the U.S. Supreme Court. The Court has declined to review the case.

Letter of the Law

If the IRS determines in a payroll tax dispute that you’re a responsible person, it will issue a letter stating that it plans to assess the trust fund penalty against you. You then have 60 days (75 days if the letter is sent to an address outside the U.S.) from the date of the letter to appeal. This communication will explain your appeal rights. If you don’t respond to the letter, the IRS will assess the penalty against you and send you a Notice and Demand for Payment.

Once the trust fund penalty is assessed, the IRS can take collection action against your personal assets. For example, it may file a federal tax lien or take levy or seizure action.

You should, of course, do everything in your power to avoid the trust fund penalty. Prioritize the IRS over any other creditors you might have. And if you can’t meet your payroll tax obligations, arrange to meet with the IRS to investigate your options (see right-hand box). Also contact your professional advisors for guidance.