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Trust Fund Recovery Penalty The purpose of this letter is to discuss a severe tax penalty for which you may be at risk—the “100% trust fund recovery” penalty—and to discuss ways to make sure you stay safely clear of it. It's called the “trust fund recovery penalty” (or simply the “trust fund penalty”) because it applies to the Social Security and income taxes required to be withheld by a business from its employees' wages. Since the taxes are considered property of the government, the employer holds them in “trust” on the government's behalf until they are paid over. It's also called the “100% penalty” because the person liable for the taxes (the “responsible person” described below) will be penalized 100% of the taxes due. Accordingly, the amounts IRS seeks when the penalty is applied are usually substantial, and IRS is very aggressive in enforcing this penalty. The trust fund recovery penalty is among the more dangerous tax penalties because it applies to a broad range of actions and to a broad range of persons. What actions are penalized? The penalty applies to any willful failure to collect, or truthfully account for and pay over Social Security and income taxes required to be withheld from employee wages. Who is at risk? The penalty can be imposed on any person “responsible” for collection and payment of the tax. This has been broadly defined to include a corporation's officers, directors, and shareholders under a duty to collect and pay the tax as well as a partnership's partners, or any employee of the business under such a duty. Even voluntary board members of tax-exempt organizations, who are generally excepted from responsibility, can be subject to this penalty under certain circumstances. Responsibility has even been extended in some cases to family members close to the business, and to attorneys and accountants. IRS says responsibility is a matter of status, duty, and authority. Anyone with the power to see that the taxes are paid may be responsible. There is often more than one responsible person in a business, but each is at risk for the entire penalty. Although a taxpayer held liable may sue other responsible persons for contribution, this is an action he must take entirely on his own after he pays the penalty. It cannot be part of the IRS collection process. Note how broadly the net can be cast: You may not be directly involved with the withholding process in your business. But if you learn of a failure to pay over withheld taxes and have the power to have them paid and instead make payments to creditors, etc., you become a responsible person. What is “willfulness?” For actions to be willful, they don't have to include an overt intent to evade taxes. Simply bowing to business pressures and paying bills or obtaining supplies instead of paying over withheld taxes due the government is willful behavior for these purposes. And just because you delegate responsibilities to someone else doesn't necessarily mean you are off the hook. Your failure to take care of the job yourself can be treated as the willful element. How to avoid the Trust Fund Recovery Penalty: Absolutely no failure to withhold and no “borrowing” from withheld amounts should ever be allowed—regardless of the circumstances.
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