Trust Fund Recovery Penalties (or TFRPs) refer to the tax penalties assessed against the responsible person(s) of a business (e.g., directors, officers, etc.) that failed to collect, account for, or pay over taxes on behalf of its employees. As a result, the failure of a business to pay over employment taxes does not necessarily stop with the business. Directors and officers may be personally liable for their actions (or inactions) with respect to the business’ employment taxes. In a recent decision by the Fifth Circuit Court of Appeals, the Court affirmed the lower court’s determination that the president and owner of certain businesses was personally responsible for trust fund recovery penalties. Further, while the taxpayer experienced “extreme personal hardship,” as well as business difficulties, those circumstances did not excuse his underlying tax responsibilities.
Tag Archive for Trust Fund Recovery Penalty
Employees are required to withhold federal income and social security taxes from the wages of their employees. If an employer fails to do so, the government will often assert the trust fund recovery penalty (“TFRP”) against those responsible for payroll decisions.
Generally, the bar to assert the TFRP is a low one. First, the government must merely show that the taxpayer was a “responsible person,” i.e., someone with a certain degree of decision-making authority over payroll. Although this almost always includes owners of the employer company, it also commonly ensnares others such as executives or directors of the company. Second, the government must show that the responsible person acted “willfully.” For these purposes, willful conduct generally means that the responsible person voluntarily chose to pay other creditors over the IRS with knowledge of the outstanding IRS payroll obligations.
The trust fund recovery penalty (TFRP) is equal to 100% of any unpaid trust fund taxes. You may become personally responsible for this penalty if the IRS determines that you are a responsible person at the business who willfully failed to send the payroll tax money to the IRS.
The TFRP is a severe penalty, and you should consult a tax attorney if you are being investigated for a possible TFRP assessment.
Negotiating The TFRP
First, you have the option to request mediation before the IRS assess the TFRP. This involves a neutral mediator who will attempt to reach a settlement between you and the IRS.
The good thing about mediation is that it isn’t binding on either party. If you don’t like the deal, the IRS can move forward with the penalty assessment and you can use your formal appeal rights.
I for one am glad that 2016 finally ended. Coming out of a contentious election with a boat load of vitriol thrown around, I don’t know about you, but I was swinging between the need for relief for it all to be over and the fear of who would take over the presidency and if it would go into capable hands. I am so glad tax season started so I can get to the business of preparing returns!
§ 5:75 In General
The practitioner’s goal in defending a Trust Fund Recovery Penalty is to remove the onus from one’s client and place it on some other person or in the alternative to limit the amount of liability. Literally, one of the best ways to protect your client is to use the “he did it” defense. Blame someone else!
§ 5:76 “He Did It” Defense
The “he did it” defense can first be asserted at the initial interview of your client. Be prepared to present documentation to support why another person bore ultimate responsibility for payment of the taxes. The best evidence may be affidavits from third parties and your client asserting that some other party was responsible.
§ 5:77 Protest
Upon receipt of the letter proposing liability, submit a protest in the format set forth on the back of the IRS letter. Even if your client is a responsible person and willfully failed to pay the tax, you may protest the computation of the tax. It is not unusual for the IRS to miscalculate the Trust Fund Recovery Penalty and you have the right to assure that the penalty is in the proper amount. Read more
§ 5:70 In General
Having completed a preliminary investigation, the Revenue Officer next prepares proposed Trust Fund Recovery Penalties against the persons whom he or she believes to be responsible persons. For this purpose the Revenue Officer prepares a report titled “Recommendation Re: Trust Fund Recovery Penalty Assessment.” The report calls for the Revenue Officer to determine whether to assert against each potentially responsible person. The Officer can decide not to assert against a responsible person if it is determined that the penalty would not be collectible from that party. (Since the Internal Revenue Service views the Trust Fund Recovery Penalty as a collection device, the author has found that the greater his client’s net worth, the less likely the IRS is to determine the client not to be a responsible person.)
§ 5:71 Notice To Taxpayer
The completed recommendation is presented to the Revenue Officer’s Group Manager for concurrence. Upon approval by the Group Manager, a Letter 1153 and Form 2751 (Proposed Assessment of Trust Fund Recovery Percent Penalty) are mailed to each potentially responsible person. The letter is mailed to the person’s last known address. That letter grants the taxpayer ten days to contact the Revenue Officer to present a defense, or the taxpayer may request an appeals conference within sixty days of the letter. The format for a protest is set forth on the reverse side of the letter. Read more
§ 5:68 In General
Once, a Revenue Officer has determined the basic financial and organizational information about a company, he or she will begin gathering supporting documents. It is standard practice to summon the company’s banks for corporate resolutions, signature cards, bank statements, cancelled checks, and loan agreements. Revenue Officers will also seek copies of contracts, leases, and corporate minutes books. Normally at the outset of the investigation, the Revenue Officer will not have the corporate tax returns, but as the investigative process begins, he or she will request copies from the Service Center.
§ 5:69 Oral Presentations
Oral presentations on behalf of your client sometimes will prevent assertion. Always point out your client’s dire financial situation when appropriate since the Internal Revenue Service might give her a pass based upon uncollectibility. [IRM 220.127.116.11]
§ 5:64 In General
At any time after an employer fails to pay trust fund taxes, the IRS may begin investigating a proposed Trust Fund Recovery Penalty. It is standard practice for the Service to begin investigating any time a Revenue Officer discovers that a company owes taxes. Many times the Revenue Officer will begin the process when the company is still operating and has entered into a payment agreement with the Service. [IRM 18.104.22.168] If the payment agreement will be for more than 18 months, the potentially responsible officers must sign a statutory waiver to avoid assessment. [IRM 5:7.4.8] The Service views the Trust Fund Recovery Penalty as a collection tool and rightly believes that the threat of personal liability will cause the management of an operating company to maximize payments to the IRS. Such a policy can create severe management disruptions if corporate officers must try to juggle corporate financial problems, conflict to each other, and the potential for personal financial devastation if they are assessed a Trust Fund Recovery Penalty. In many areas, the Service will assess responsible persons and begin collection from the officers even though the corporation is still operating and making payments on its overdue taxes. [IRM 22.214.171.124]
§ 5:65 Interviews With Potentially Responsible Persons
The IRS normally begins its investigation Fund Recovery Penalty by interviewing corporate officers. The IRS utilizes an interview form titled “Report of Interview Held with Persons Relative to Recommendation of 100-Percent Penalty Assessments.” Upon review of the form you will note that the interview format takes two approaches: (1) the gathering of corporate financial and organizational information; and (2) the gathering of information relative to proving responsibility and willfulness. Read more
§ 5:61 In General
In proposing a Trust Fund Recovery Penalty, an IRS Revenue Officer will secure transcripts of all the unpaid tax periods of a corporation. The Officer will then complete a computation sheet. Revenue Officers are instructed to compute the proposed penalty in a manner most advantageous to the government. [Rev. Proc. 2002-26; Rev. Rul. 73-304, 1973-2 C.B. 42; Rev. Rul. 79-284, 1979-2 C.B. 83] As tax practitioners, our goal, obviously, is to compute the proposed penalty in a manner most advantageous to the client. In every case, recompute the proposed penalty. By reviewing the computation and IRS transcripts one can verify the proper computation of the penalty. Many times the Revenue Officer has failed to follow even the guidelines set out in the Internal Revenue Manual.
§ 5:62 Payments Applied To Accrued Interest And Penalties
Of particular interest is the position of the IRS that it may apply payments to accrued interest and accrued penalty prior to paying assessed trust fund taxes. The IRS computer does not apply payments in this manner on the corporate account. It only applies payments to accrued penalty and interest when all assessed tax penalty and interest has been paid. The computer does apply payments in the manner set forth in Appendix 5C when it is computing the Trust Fund Recovery Penalty. It is certainly arguable that the IRS should compute a proposed Read more
§ 5:52 In General
One method of reducing the potential trust fund liability is to assure that the employer designates each payment made on account by placing a restrictive endorsement on the back of each check worded as follows:
“Direct to Trust Fund Portion of taxes only for the period ended for Corporation.” [IRM 5.7.7 & IRM 8.11.2]
§ 5:53 Designated Payments
The Internal Revenue Manual directs that the Service will follow the taxpayer’s direction of payments and states as follows:
“A designated payment is a voluntary one that the taxpayer has directed to be applied in a particular manner; i.e., a specific period, kind of tax, tax portion, interest, etc. Normally such direction will be followed by the Service.” [IRM 126.96.36.199]
§ 5:54 Contemporaneous Direction
The courts have consistently held that a designation made contemporaneously with a payment must be applied by the Internal Revenue Service in accordance with such direction. Therefore, if you make a designation on the back of the check, the entire amount must be applied toward the trust fund portion. The direction must be written, and the IRS need not honor an oral direction. Read more
§ 5:50 In General
I.R.C. § 7501 states that withheld taxes “shall be held to be a special trust fund interest for the United States.” The purpose of the Trust Fund Recovery Penalty provision is to collect from individuals only unpaid funds held in trust by the employer. Therefore, a practitioner must know how the Trust Fund Recovery Penalty is computed.
§ 5:51 Amount Of Penalty
The amount of the penalty is the amount of the trust fund. The trust fund is comprised of only the withheld taxes, i.e., withheld income tax and the employee’s share of Social Security tax. The trust fund does not include the employer’s matching share of the Social Security tax because those funds are not withheld from the employee’s wages. The employer’s share of social security taxes, and all penalties and interest, are corporate obligations that do not pass through as a personal liability to the individual. They are not required to be held in trust for the government and, therefore, should not be included in the amount of the Trust Fund Recovery Penalty. The author has found that the Service consistently miscalculates the trust fund portion, therefore, the practitioner must always verify the calculation of a proposed Trust Fund Recovery Penalty. See the “Computation Sheet” that is used by the Internal Revenue Service to compute trust fund portion.
§ 5:47 In General
Under the Code, a Trust Fund Recovery Penalty must be assessed within three years of the April 15th following the year during which the quarterly liabilities arose. [I.R.C. § 6501 (a), (b)(2)] For example, the penalty with respect to liabilities arising during 1985 must be assessed on or before April 15, 1989. If the return is filed later than the April 15th following the year during which the liability arose, the statutory period for assessment is three years from the date of filing. If the returns were prepared by the IBS pursuant to I.R.C. § 6020(b), the IRS contends that there is no statute of limitations. [LR.C. § 6020(b)]. The .Internal Revenue Service in the past attempted to argue that there is no statute of limitation for the § 6672 penalty. The Third Circuit, however, ruled that the statute of limitation provided in § 6501(a) does apply to assessments of § 6672 Liabilities.
§ 5:48 Extension During Appeal
If a written preliminary notice of proposed liability is mailed or delivered in person to a ”responsible person-‘ before the’ expiration of the statute of limitations for the assessment of the penalty, the statute will not expire before the later of:
(1) 90 days after the date the notice was mailed or delivered in person, or
(2) if there is a timely protest of the proposed assessment, 30 days after a determination on the protest. Read more