To encourage payment of withheld income and employment taxes, including social security taxes, railroad retirement taxes, or collected excise taxes, Congress passed a law that provides for authority for the IRS to assess the Trust Fund Recovery Penalty (TFRP). These taxes are called trust fund taxes because the business holds the employee’s money in trust until it makes a federal tax deposit in that amount. The TFRP may apply to you if these unpaid trust fund taxes cannot be immediately collected from the business, or have not been remitted to the IRS. The business does not have to have stopped operating in order for the TFRP to be assessed.
Generally, employers are required to deposit federal income tax withheld and both the employer and employee portions of Social Security and Medicare taxes under one of three timing rules: the monthly rule, the semi-weekly rule, or the one day rule, depending on the amount of taxes accumulated. See Treas. Reg. §§ 31.6302-1(c).
Calculating the Trust Fund Recovery Penalty Amount
The amount of the penalty is equal to the unpaid balance of the trust fund tax. The penalty is computed based on:
- The unpaid income taxes withheld, plus
- The employee’s portion of the withheld FICA taxes.
For collected taxes, the penalty is based on the unpaid amount of collected excise taxes.
Who Can Be Responsible for the TFRP
The TFRP may be assessed against any person who:
- Is responsible for collecting or paying withheld income and employment taxes, or for paying collected excise taxes; and
- Willfully fails to collect or pay them.
A responsible person is a person or group of people who has the duty to perform and the power to direct the collecting, accounting, and paying of trust fund taxes. See IRC 6672. This person may be:
- An officer or an employee of a corporation,
- A member or employee of a partnership,
- A corporate director or shareholder,
- A member of a board of trustees of a nonprofit organization,
- Another person with authority and control over funds to direct their disbursement,
- Another corporation or third party payer,
- Payroll Service Providers (PSP) or responsible parties within a PSP
- Professional Employer Organizations (PEO) or responsible parties within a PEO, or
- Responsible parties within the common law employer (client of PSP/PEO).
For willfulness to exist, the responsible person:
- Must have been, or should have been, aware of the outstanding taxes and
- Either intentionally disregarded the law or was plainly indifferent to its requirements (no evil intent or bad motive is required).
Notice of Proposed Assessment for the TFRP
After completing his or her investigation, the revenue officer will prepare Form 4183, Penalty Assessment Recommendation. After the form is approved by the group manager, the Service will issue Letter 1153(DO) (the “60 Day Letter”) and Form 2751, Proposed Assessment of Trust Fund Recovery Penalty. The notice must be mailed to the taxpayer’s last known address or hand delivered. In advance of the hearing, the taxpayer should obtain copies of all Forms 4180 and request the same from the revenue officer or the appeals officer assigned to the case.
Appealing the Trust Fund Recovery Penalty
If the IRS determines that you are a responsible person, they will provide you a letter stating that they plan to assess the TFRP against you. You have 60 days (75 days if this letter is addressed to you outside the United States) from the date of this letter to appeal our proposal. The letter will explain your appeal rights. Refer to Publication 5, Your Appeal Rights and How to Prepare a Protest if You Don’t Agree (PDF), for a clear outline of the appeals process. If you do not respond to our letter, the IRS will assess the penalty against you and send you a Notice and Demand for Payment.
In advance of the hearing, the taxpayer should obtain copies of all Forms 4180 and request the same from the revenue officer or the appeals officer assigned to the case.
Claim for Refund Appeal of Trust Fund Recovery Penalty Assessment
The Tax Court does not have jurisdiction to determine whether the Internal Revenue Service’s assessment of the trust fund recovery penalty is correct. Medelros v. Comm’r, 77 T.C. 1255 (1981). However, the Tax Court may review a trust fund penalty determination if it is before the court on a review of a collection due process notice of determination. See IRC § 6330(d). In order to contest the Service’s determination, the taxpayer assessed with the trust fund penalty must:
- Pay the portion of the trust fund recovery penalty attributable to one employee for each quarter at issue. Employment taxes and the trust fund recovery penalty are “divisible” taxes; Therefore, they are not subject to the Flora full payment rule. Steele v. U.S., 280 F.2d 89, 90-91 (8th Cir. 1960).
- File a claim for refund on Form 843, Claim for Refund and Request for Abatement, for each tax period and type of penalty. IRC § 7422; Treas. Reg. § 301.6402-2(d); IRM 126.96.36.199 (08-11-2004); additionally, form 843 serves as both a claim for refund and a request to have the unpaid portion abated
If that claim for refund is denied, or deemed denied if the Service fails to respond within 6 months, the taxpayer can file a refund suit in the federal district court in which the taxpayer resides or the Court of Federal Claims.
A taxpayer has two years from the date of payment to file a refund claim. IRC § 6511(a). A taxpayer may waive the Notice of Claim Disallowance under IRC § 6532. Treas. Reg. § 301.6532-1(c)(4). Upon denial, the responsible person has two years in which to bring a refund suit. IRC § 6532(a)(1).
Contact a tax attorney if you have any questions about appealing a trust fund recovery penalty assessment.