\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0A Powerful Tax Collection Device Used to Impose Personal Liability
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Proposed assessments of the Trust Fund Recovery Penalty (TFRP) are one of the most serious tax matters a client may encounter. Also known as the "Responsible Person Penalty" and the "100% Penalty" the TFRP is frequently imposed by the Internal Revenue Service (IRS) on individuals associated with businesses that have failed to collect and pay over taxes that should have been withheld from their employees' wages. In addition, the TFRP may also be assessed in other situations where one taxpayer, who is required to collect or withhold tax from another taxpayer, fails to pay the withheld funds to the IRS.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0The TFRP, which typically involves large sums arising out of repeated failures to pay over taxes, essentially provides the IRS with a mechanism for imposing personal liability on individuals for unpaid taxes owed by corporations and limited liability companies. As a result, an understanding of the TFRP is essential to the effective representation of clients who find themselves faced with this dilemma.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0The operative terms of the TFRP
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Code § 75011 generally defines "trust fund taxes" to include taxes that one person must collect or withhold from another person: "Whenever any person is required to collect or withhold any internal revenue tax from any other person and to pay over such tax to the United States, the amount of tax so collected or withheld shall be held to be a special fund in trust for the United States."2
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0The TFRP is authorized by Code § 6672. In short, it provides that any person who is required to collect and pay trust fund taxes, but who "willfully fails" to do so, is liable for a penalty equal to the total amount of the tax not collected and paid over to the IRS.3 Individuals who are required to collect or withhold taxes are frequently referred to as "responsible persons."
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0For purposes of applying the TFRP, the term "person" is defined by Code § 6671(b) as "an officer or employee of a corporation, or a member or employee of a partner-ship, who as such officer, employee, or member is under a duty to perform the act [i.e., the collection/withholding and payment of trust fund taxes to the IRS] in respect of which the violation occurs."4 Furthermore, Code § 7701(a)(1) provides that a "person" may include "an individual, a trust, estate, partnership, association, company or corporation."5
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Usually, a responsible person will include someone within the formal structure of the business. However, the courts have held that responsible persons may sometimes include third parties, such as lenders or creditors.6 In any case, the determining factor is whether the potential responsible person had the authority to control or direct payments of the business.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Thus, there are two key components needed to support the imposition of the TFRP: (1) the existence of one or more "responsible person^)" and (2) the willful failure on the part of the "responsible person(s)" to withhold and pay the trust fund taxes to the IRS.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Examples of trust fund taxes and non-trust fund taxes
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0As noted, a tax will be considered a "trust fund tax" if a responsible person is required to withhold or collect it from another taxpayer. Examples of "trust fund taxes," which need not have been actually withheld, include the following: (1) income taxes required to be withheld from employees' wages (Code § 3402); (2) the portion of the FICA tax required to be withheld from employees' wages (i.e., "Social Security taxes" imposed by Code §§ 3101 and 3102(a)); (3) taxes required to be withheld on pensions, annuities and certain other deferred income (Code § 3405); (4) any required "backup" withholding, as with taxpayers who fail to provide correct Social Security numbers (Code § 3406); and (5) excise taxes (Code §§ 4001-4682).
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0The following items are not considered to be trust fund taxes: (1) income taxes imposed on and paid directly by entities, such as income taxes paid by corporations; (2) the employer's share of FICA taxes (Code § 3111); (3) the Federal Unemployment Tax (Code § 3301); (4) self-employment tax (Code § 1401); and (5) deposit penalties and other penalties, such as the late-filing and late-payment penalties.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0As noted later in this article, the distinction between trust fund and non-trust fund taxes may be important when attempting to minimize personal liability.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0The TFRP is actually a collection device
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Although the TFRP is called a "penalty," it is actually a mechanism to collect unpaid trust fund taxes. As noted in the Internal Revenue Manual, "[i]t serves as an alternative means of collecting unpaid trust fund taxes when taxes are not fully collectible from the company/business that failed to pay the taxes."7 The ability of the IRS to impose individual liability for taxes owed by a corporation or some other type of entity often comes as a surprise to clients who deliberately took steps to shield themselves from the debts of their businesses.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0If the IRS succeeds in collecting the trust fund taxes from a business, it will not also seek to impose the TFRP as a separate penalty. The IRS, however, may seek to collect from multiple "responsible persons" at the same time, which may temporarily result in "double collection" to ensure that it will recover and keep the taxes.8 Consistent with this approach, the IRS need not exhaust its remedies against all potential responsible persons before attempting to pursue a particular responsible person.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Potential "responsible persons"
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0When attempting to identify responsible persons, the IRS will attempt to identify and/or consider the following: (1) the individuals listed as officers, directors or shareholders; (2) the duties of the officers as set forth in the corporate bylaws; (3) the ability of individual(s) to sign checks, whether or not the individual actually did so; (4) the person(s) in control of the financial affairs of the business; (5) the person^) who hired and fired employ- e es; (6) the person(s) who had the authority to determine which creditors would be paid and those who exercised that authority; (7) the person^) who signed and filed returns (e.g., Form 941); (8) the...