Employers, as a matter of course, withhold employment taxes (including Social Security taxes) and income taxes from employees’ pay. These withheld funds are held in trust until the person responsible for paying them makes a federal tax deposit of the funds. In order to ensure these tax deposits are made in a timely fashion, Congress enacted a law providing for a Trust Fund Recovery Penalty (TFRP). This penalty is applied to any person responsible for paying payroll taxes who willfully fails to do so. The TFRP may be assessed whether or not a business is still in operation.
The TFRP may come into play when a business is having problems with cash flow, and chooses to access withheld funds to ease the strain. Typically, the business views this as a short-term fix, and has every intention of replacing the funds before they are due to the IRS. However, if financial difficulties continue, the business may borrow greater amounts or may be unable to replace the funds already borrowed.
Who is a “Responsible Person” with Regard to the TFRP?
As a general rule, the corporate form shields individuals from liability for the business’ actions. However, this corporate shield does not apply in the case of the TFRP. Individuals who are “responsible persons” may be personally liable for the penalty.
Who, then, qualifies as a responsible person? A responsible person is a person, or a group of people who are charged with collecting, accounting, and paying trust fund taxes. Such a person might include an officer or employee of a corporation or partnership, a corporate director, a member of the board of trustees for a nonprofit organization, a payroll service provider, or any person with the authority and control to direct the disbursement of funds. What defines a “responsible person” is having the duty to pay over to the IRS taxes that have been withheld.
The IRS considers multiple factors in determining whether an individual is a “responsible person” with regard to the TFRP, including his or her corporate status, duties within the organization, signature authority over corporate accounts, and ability to decide which creditors of the business are paid before others. Whether one is a “responsible person” is a factual determination made after looking at all circumstances of the case.
It’s important to note that a “responsible person” need not have ultimate control over disbursements, so long as he or she exercises significant control.
What is a “Willful Failure” to Pay Withheld Tax Funds?
Willfulness generally refers to a deliberate choice to direct funds to other creditors rather than to the IRS, when the responsible person knew the business was not paying its taxes (or recklessly disregarded that fact). There is no requirement of bad faith to find a willful failure. If the individual knew that taxes were delinquent, he or she is obligated to confirm that the situation has been corrected, and should not rely on the assurances of others. It’s likely that if a person has been deemed a “responsible person” for purposes of the TFRP, it’s going to be difficult to show that any failure to pay withheld taxes was not willful.
For example, holding a genuine, though mistaken, belief that the business was obligated to pay other creditors before the IRS is not a defense to willfulness. Courts have suggested that “reasonable cause” might be an acceptable defense, but in practice reasonable cause for failure to pay taxes has been difficult to prove. At least one court has held that an employee who was directed by the company’s owner to not pay the taxes should have risked termination rather than violate this law.
If you believe that you are in a position to be held liable for failure to pay withheld tax funds, you should consult an experienced tax attorney without delay. The attorneys of Ortiz & Gosalia, PLLChave post-JD degrees in tax law and can help you to understand and attempt to mitigate your risk. With offices in Redmond, Bellevue and Kirkland, we offer services throughout the Seattle area and Washington State. If you would like to learn more about the TFRP, including the assessment process, we invite you to contact us.