Legal Insights Q&A with David Looby
Payroll Taxes & the Trust Fund Recovery Penalty
Q: Who is required to withhold payroll taxes?
A: An employer is required to withhold federal income and payroll taxes (the employee portion of Social Security and Medicare taxes (FICA)) from its employees’ wages to remit to the IRS. Withheld federal income and FICA taxes are called trust fund taxes. The employer is required to hold these employee monies in trust until a federal tax deposit of that amount is made to the IRS. Willful failure to remit the withheld portion to the IRS can result in a "responsible person" being held personally liable for 100% of the unpaid tax (commonly referred to as the trust fund recovery penalty).
Q: Who is considered a responsible person?
A: A "responsible person" includes an officer or employee of a corporation; a member or employee of a partnership; who as such officer, employee, or member is under a duty to pay over the withheld taxes. Many persons associated with a business could be found by the IRS to be a responsible person. The crucial test in determining responsible person status is whether the person possesses the authority to exercise significant control over a company’s financial affairs. Several factors indicate responsibility, including whether the person (1) has the authority to sign checks; (2) has control over the company’s payroll; (3) has the authority to direct payments to creditors; and (4) prepares and signs employment tax returns. No one factor is determinative and responsible person status will ultimately depend on the facts and circumstances of each case.
Q: What is willful failure?
A: Even if an individual is found to be a responsible person by the IRS, a determination must still be made as to whether that individual was "willful" in failing to pay the withheld taxes to the IRS. Willfulness has been defined as "a voluntary, conscious and intentional decision to prefer other creditors over the [IRS]." (Muck, 3 F.3d 1378, 1381 (10th Cir. 1993)). Willfulness is present if a responsible person chooses to pay other creditors over the IRS – even though the individual is aware or recklessly disregards that the company is not paying the taxes.
Q: How do I avoid the penalty?
A: The best way for a responsible person to avoid the penalty is to timely remit the withheld taxes to the IRS. There are very few defenses to the penalty and the IRS takes an extremely aggressive position against a responsible person for failure to pay. A responsible person can also potentially be criminally liable. If you or your company owes payroll taxes, and the IRS has initiated collection efforts, it is important to immediately seek help from an attorney.