You are if you’re an employer who willfully failed to deposit with the Treasury the required income taxes and the employee share of FICA withheld from wages.
These taxes are called trust fund taxes because you are withholding and depositing them on behalf of employees. Unfortunately, when cash is tight, some employers may use these funds to pay other bills. A report from the Treasury Inspector General for Tax Administration said that as of June 30, 2012, employers owed the government $14.1 billion in delinquent employment taxes.
What the report found
It criticized the government for not taking sufficient collection action in trust fund recovery penalty (TFRP) cases. For example, the IRS often failed to initiate collections before the statute of limitations on collections expired. But even if the collection period was still open, by delaying collections, the financial ability to pay had declined. While only a small sample of employers was used, the report found that the untimely actions averaged more than 500 days to review and process.
The report recommended that the IRS should:
- Ensure that revenue officers take timely action for TFRP cases
- Enhance communications and training for TFRP cases
- Improve the IRS scheduling system so collections cases aren’t barred by the statute of limitations
The report contained a memorandum sent to the IRS commissioner of the Small Business/Self-Employed Division. It acknowledged that the division has made some improvements in timeliness since the Government Accountability Office’s recommendations made in 2008 along similar lines.
When employers are personally liable
Regardless of the entity used for your business, you are personally liable for a 100% TFRP if you are a “responsible person” who willfully fails to deposit the trust fund taxes within the meaning of the tax law. Thus, even if you own a corporation or limited liability company, you are personally at risk for this penalty if you are an owner who is aware that the taxes haven’t been deposited and who has authority over which bills get paid (e.g., ability to sign checks, review payments).
If there is more than one “responsible person,” the IRS is free to go after any such individual for the entire penalty. Then the person who pays the taxes can seek “contribution” (the pro rata share) from co-owners (the responsible person can ask his/her co-owners for their share but likely a lawsuit is needed).
What to do
In light of the Inspector General’s report and the huge amount of revenue at stake, small business owners can expect that the IRS’ SB/SE Division will be more attuned to uncollected trust fund taxes. To avoid exposure to this personal penalty, be sure that your business implements strategies to pay this tax obligation, including:
- Regular monitoring of deposits with the Treasury for trust fund taxes
- Using cash flow strategies so as not to fall short of the funds needed to make the tax deposits
- Working with tax advisors to ensure that payroll taxes are properly computed and deposited according to the applicable deposit schedule