How to Avoid Trust Fund Recovery Penalty

how to avoid trust fund recovery penalty

If you own or manage a business with employees, you may be subject to a punitive tax penalty known as the “Trust Fund Recovery Penalty” or TFRP. The TFRP pertains to the trust fund taxes such as Social Security and income taxes that businesses are obligated to withhold from their employee’s paychecks. These taxes are called trust fund taxes because an employer or financial manager holds these taxes in “trust” until they make a federal tax deposit in that amount. 

To encourage prompt payment of withheld income and employment taxes, including railroad retirement taxes, social security taxes,  or collected excise taxes, Congress passed a law that provides for the Trust Fund Recovery Penalty. 

Furthermore, the TFRP may be assessed against any person who:

  • Is responsible for the collection or payment of withheld income and employment taxes; and
  • Willfully fails in collecting or paying collected excise taxes. 

Who is Considered being a Responsible Person?

The extent of influence an individual has over corporate payments and finances is the key to deciding whether he or she is considered “responsible” for payroll taxes. Individuals must have actual authority over how the company’s finances are disbursed, not just a title, to be considered accountable. 

While ministerial responsibilities are insufficient to establish “control,” the IRS believes that an individual does not need to have a final decision over how funds are spent. As such, you can be considered a responsible person if you are:

  • An officer or member of the board of directors;
  • Active in the management of day-to-day financial affairs of the company
  • An individual who owns shares or possesses an entrepreneurial stake in the company
  • The one who makes a decision regarding which, when and in what order, outstanding debts or taxes will be paid
  • The one who has the ability to hire and fire employees
  • A person who exercises control over daily bank accounts and disbursement records
  • An individual who has check-signing authority

Although there may be more than one person in a business who may be considered responsible, each one of them is at risk for the entire TFRP.  Even if you aren’t directly involved in your company’s payroll tax withholding taxes procedure, you could become a responsible party if you have the ability to pay over withheld taxes and learn of a failure to pay them, but rather choose to pay creditors and others.

What considers a Willful Action?

Willful action occurs when a person succumbs to pressures from (or on) their business and chooses to pay invoices or procure supplies rather than paying withheld income taxes that are due. 

As such, for willfulness to exist, the responsible person should have been or must have been aware of the outstanding taxes, and they either intentionally disregarded the law or were plainly indifferent to its requirements. Delegating obligations to others does not necessarily absolve you of accountability, as failing to do the task yourself may be deemed a willful act.

Factors in Figuring the TFRP Amount

The amount of the Trust Fund Recovery Penalty is equal to the unpaid amount of the trust fund taxes. The computation of this penalty is based on these factors:

  • The unpaid taxes withheld
  • The employee’s trust fund portion of the withheld FICA taxes.

For the collected income and trust fund taxes, the penalty is based on the unpaid balance of collected excise taxes.

Assessing the Trust Fund Recovery Penalty 

If the IRS determines that you’re a responsible person, it will provide a letter that states the plan to assess a TFRP against you. You will only have 60 days from the date of the letter or up to 75 days if the letter is addressed outside the US to appeal the IRS proposal. However, if the agency will not hear from you or respond to their letter, it will automatically assess the penalty against you and send you a Notice and Demand for Payment. 

Avoiding the Trust Fund Recovery Penalty

You must never neglect to withhold taxes, and must never “borrow” from withheld sums under any circumstances to avoid the Trust Fund Recovery Penalty. Furthermore, be certain that any money withheld is paid to the government on schedule.

Hence, You can avoid such a penalty by ensuring that all employment taxes are collected, accounted for, and paid to the Internal Revenue Service when required. As long as your business collects taxes from all employees and pays payroll taxes on time using IRS Form 941, you won’t have to worry about getting charged with a large sum of penalty.

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