Your Guide to the IRS Trust Fund Recovery Penalty
Just like individual taxpayers, businesses must closely follow all tax regulations to stay in compliance and avoid penalties. This can be especially cumbersome if you have employees.
One area where many business owners get into trouble is payroll and related tax procedures. Not only do employers have to collect taxes from employee paychecks, but they also have to send what they withhold as tax deposits to the government.
Failure to follow these guidelines can lead to fines, penalties, and eventually even legal trouble. So, it’s important to establish a process for compliance. Get to know something called the trust fund recovery penalty (TFRP), which, despite the somewhat misleading name, applies to businesses that have to remit employment taxes.
This guide covers the ins and outs of the TFRP and how to avoid this and other tax penalties.
What Are Trust Fund Taxes?
First, it’s important to understand what trust fund taxes are. The name makes it sound like they only apply to people with personal trust funds. However, these are taxes that employers withhold from their employees’ paychecks—Social Security, Medicare, and income taxes. As the IRS states, employers “have the added responsibility of withholding taxes from their paychecks.”
The reason these funds are called trust fund taxes is that they’re held in trust until payment is made to the U.S. Treasury Department via federal tax deposits (FTDs).
Note that workers like self-employed individuals are responsible for paying these taxes themselves since they don’t have an employer to do it for them. Contractors thus have to pay quarterly estimated taxes each quarter, in addition to an annual return, similar to a business.
Basics of the Trust Fund Recovery Penalty
If an employer fails to remit the trust fund taxes it withholds from employees’ wages to the Treasury by the applicable deadline, the TFRP may come into play. This penalty can be pretty hefty, so it’s best to avoid it.
It’s easy to calculate the TFRP. It doubles the applicable tax bill because the penalty is equal to the unpaid employment taxes you owe. So, if you owe $3,000 in trust fund taxes and don’t pay them, your penalty would be $3,000, and your total would become $6,000 to pay.
Even while the TFRP is a business-related penalty, there’s an important distinction: it’s assessed to individuals, not the business as a whole. The IRS will investigate the situation to determine who was responsible for the unpaid taxes.
This process is discussed in more detail next.
Note that the trust fund penalty only applies to the taxes that were withheld and not paid. It does not apply to the employer’s matching portion of the taxes. In most cases, you won’t face a TFRP until the taxes are seriously delinquent. If they are only late, you will incur deposit and/or late filing penalties. The first penalty the IRS usually assesses if the failure to deposit penalty which is 2% of the payment due.
Who Is Responsible for the TFRP?
The IRS states that anyone responsible for collecting or paying trust fund taxes, or for sending excise taxes, may be hit with the TFRP if they were also willful in their actions. The responsible person is whoever is in charge of collecting, paying, and accounting for trust fund taxes, or directing these activities.
Here’s who a responsible party could be at your organization:
- An employee
- An officer
- A partnership member
- A corporate director or shareholder
- A board member
- Someone who controls fund disbursement
- A third-party payer
- A payroll service provider
- A professional employer organization (PEO)
Then comes the “willful” component. Willfulness exists if the responsible party knew or should have known about the outstanding tax and they were indifferent to or intentionally disregarded the law.
These rules and guidelines can be tricky, so when you’re not sure about your involvement in unpaid taxes, talk to a tax attorney who can help you understand your situation.
What Is the Form 4180 Interview?
The IRS also has a process for determining the responsible party for unpaid trust fund taxes. They will conduct something called the Form 4180 interview, wherein they talk to involved parties and assess their involvement in financial processes within the business.
Form 4180 is what the IRS agent will use to ask you questions, so that’s where the name of the interview comes from. This form is the Individual Relative to Trust Fund Recovery Penalty.
The IRS wants to know who was responsible for paying the tax, who was aware of the unpaid tax, and who was in charge of the entire process. If you are involved in these interviews, make sure you are fully prepared to provide the requested information and that you are always open and honest with the agent.
The TFRP Assessment Process
The IRS discovers unpaid tax based on the information and forms it receives, such as employee W-2s, and uncovers responsibility through the Form 4180 interview.
When the agency figures out that you haven’t paid employment taxes you withheld, and that you are the responsible party for this error, you will likely be hit with the TFRP assessment. Here’s how that process works:
Letter 1153
This letter is the Proposed Trust Fund Recovery Penalty Assessment. It will provide the details about your violation, the penalty amount, and how to pay the penalty. Read this form thoroughly. It also includes information on how to appeal the penalty, and you usually have 60 days to do that.
Form 2751
This is the Consent to Assessment and Collection that you’ll get alongside Letter 1153. If you agree to the enclosed assessment, you will sign this document indicating that agreement. Then, the IRS will assess the penalty against you.
If you don’t agree to the penalty assessment, you get the chance to appeal. If you are successful, the IRS will not assess the penalty. If you lose the appeal, the penalty will be assessed at that point, but you may be able to enter additional appeals.
How to Avoid the Trust Fund Recovery Penalty
Don’t let all this TFRP information scare you. There are steps you can take now to ensure you don’t have to deal with this penalty or mitigate the repercussions. Here are a few best practices for avoiding the TFRP:
Follow All Employment Tax Laws
You first need to carefully comply with all tax laws related to employment. This means withholding taxes from paychecks and depositing what’s owed for your employees. Pay close attention to changing tax laws and requirements, or designate a team member to keep tabs on trends in the tax world.
File and Pay Taxes on Time
Missing a tax deadline can quickly lead to a penalty. Depending on your business situation, you may need to deposit employment taxes monthly or semi-weekly. Any federal taxes can be submitted electronically through the government’s Electronic Federal Tax Payment System (EFTPS), which is free to use. Employers typically need to file Form 941, Employer’s Quarterly Federal Tax Return, and then the annual federal unemployment tax return as well.
Get Organized
To stay compliant and ensure accuracy, you need robust recordkeeping and reporting systems in place. This means tracking payroll activities and tax withholdings, monitoring deadlines, and using reminders and notifications. With more organized processes, you’re less likely to make a mistake that can lead to a penalty.
Be Proactive and Prompt with Issues
Any size or type of business may face system errors, process roadblocks, or inaccuracies from time to time. Mistakes happen. However, be prompt when you notice an issue. Perhaps a number was incorrectly entered or a deadline was missed. As soon as you discover a problem, take steps to correct it. The faster you act the better. Learn from past mistakes, too, and be proactive in avoiding those issues in the future with additional guardrails in place.
Work with a Tax Professional
When in doubt, it’s always best to talk to a tax expert. Whether you missed a deadline, made a reporting mistake, or received an assessment of the trust fund tax penalty, work with a tax attorney or CPA who can explain the situation and come up with a game plan moving forward. You don’t want to risk making the situation worse.
What If You Can’t Pay the Trust Fund Recovery Penalty?
The first thing may taxpayers do when hit with a penalty is panic. What if you can’t pay right now? You do have a few options if this is the case.
First, consider applying for relief with the IRS. They will usually work with you to get your debt resolved. These two common options can help:
- Offer in compromise: If you can’t pay your tax bill, you may be eligible to settle your debt with an offer in compromise. You’ll send in an offer and explain your financial situation, and if the IRS believes the amount is all they can reasonably expect to collect from you, they’ll accept it.
- Payment plan: You can also apply for an installment agreement, which is more common. Under this arrangement, you pay off your debt in monthly installments.
If you simply don’t agree with the tax assessment, you could try to appeal the penalty, discussed in the next section. If you simply ignore the IRS notices and fail to comply or pay, you could eventually face additional fines and even legal problems.
How to Appeal the TFRP
Sometimes the IRS does get things wrong. If you don’t agree with their conclusion or penalty, or you were not the responsible person involved, you have the option to appeal. Talk to a tax expert to figure out if this is the right option.
Take a look at your Letter 1153 you received in the mail. Each of these documents has instructions to follow to submit an appeal. You will usually have to provide the IRS with information about your argument, including financial documents or records of compliance.
Your letter will state applicable deadlines, but you’ll usually have 60 days from the letter’s date to appeal the penalty.
Getting Help with Business Tax Penalties
Dealing with a trust fund recovery penalty is never fun. However, understanding what caused the penalty, how to deal with it, and how to get relief are all ways to move forward. You can prevent this penalty altogether by ensuring a robust compliance framework for collecting and paying employment taxes.
When you need assistance with the TFRP or paying payroll taxes, talk to the team at Seattle Legal Services, PLLC. Our tax experts have many years of experience navigating tax law and helping businesses get through the toughest tax challenges.
Contact us today to get started with a consultation.
FAQs about the TFRP
Am I responsible for paying the tax fund recovery penalty?
The IRS will determine who is responsible for the TFRP when taxes go unpaid. You are responsible if your duty is to collect and remit employment tax payments or you oversee this process, or you knew about the business’s failure to pay.
What happens during a Form 4180 interview?
Form 4180 outlines questions for IRS agents to ask business representatives. The goal is for the agent to figure out who was responsible for the unpaid trust fund taxes and who knew about the failure to pay. The agent will then send the responsible party information about the TFRP.
How much is the TFRP?
The exact penalty amount varies since it is equal to the amount of unpaid taxes you have that caused the penalty. So, the TFRP essentially doubles your tax balance.
What if I don’t pay the TFRP?
If you don’t take steps to appeal the penalty within 60 days, you don’t apply for a payment plan or other IRS tax relief, and you continue to ignore notices, you may get hit with further penalties, building interest, and eventual legal action, such as the IRS filing a federal lien on your property so they can seize it. You never want to be in this situation, so always deal with the issue as soon as possible.
Does the IRS have a statute of limitations for the TFRP?
The IRS has three years to assess a penalty on unpaid taxes, which starts on the April 15 after the year that trust fund taxes were due. However, they have 10 years to collect on a penalty.
For instance, say the IRS assesses the TFRP because you failed to remit trust fund taxes. The IRS has 10 years to collect that penalty, meaning within those 10 years they can take steps to seize your property if you don’t pay it.