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FAQs: Trust Fund Recovery Penalty

I own a small business and have several employees. I used to regularly collect the required payroll tax from my employees and pay it over to the government. Two years ago, my business experienced a cash flow problem. In order to meet the general business expenses, I was forced to use the sums that I had collected from my employees as payroll taxes. I hoped that as the economy improved, I would be able to generate more income and pay back the delinquent taxes. However, in the past two years I have fallen further behind and now owe tens of thousands of dollars in back taxes. Recently, I received a notice from the IRS informing that I was found to be the responsible person for these taxes. The notice said that I was now personally responsible for these delinquent business taxes. What does this mean and what should I do now?

This question describes the usual circumstances confronted by thousands of small businesses nationwide during the recent economic downturn. When a business faces a financial crisis, the payroll and employment taxes collected from the employees are sometimes used for general business purposes or paid to business creditors instead of being turned over to the government. Section 6672 of the Tax Code states that when a business fails to remit employment taxes to the IRS, those taxes can become the personal responsibility of the "responsible person" within the business. In other words, responsible persons within a business become personally responsible for the business taxes. These taxes are usually called trust fund taxes because the business was to collect and hold them in trust for the government.

A responsible person could be an officer or employee of a corporation, a shareholder, a corporate director or a partner in a partnership. In determining who a "responsible person" is for the purposes of delinquent trust fund taxes, the IRS looks into the nature of job responsibilities of the individuals. Usually, when a person has the authority to decide which of the creditors to pay, or is in charge of collecting and paying over the tax to the government, he or she is designated as a responsible person for the purposes of the trust fund taxes. The IRS then assesses a penalty on such individual called the trust fund recovery penalty. Under Tax Code Section 6672(a), the penalty for failing to collect and pay over tax, or attempting to evade or defeat tax, is equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.

In order to impose the trust fund recovery penalty, two separate elements of the statutory language of Tax Code Section 6672 need to be met. First, the IRS has to show that the individual in question was indeed a "responsible person" within the meaning of the statute. The IRS must carry the burden of proof on this issue. If the IRS successfully meets this burden, the "responsible person" must show that his or her failure to pay over the trust fund taxes was not "willful". Willfulness is not defined in the statute but courts have held that it denotes a conscious and voluntary decision to pay other creditors instead of the government.

Who a "responsible person" is and what constitutes "willfulness" have been the subject of many court cases. A successful defense against the imposition of the trust fund penalty by the IRS requires the close reading and thorough understanding of the relevant statutes and the court cases. If you suspect that the IRS may seek to assess the trust fund recovery penalty against you, you should consult an experienced tax attorney and seek expert advice on how to best defend against the IRS claims.