To influence prompt payment by California employers for workers in Los Angeles County, Ventura County, Santa Barbara County and Orange County of withheld income and employment taxes including social security taxes, Congress passed a law that provides for the trust fund recovery penalty (“TFRP”).
The TFRP is the same as the so-called 100% penalty. These taxes are called trust fund taxes because as a California employer you actually hold the employee’s money in trust until you make a federal tax deposit in that amount. As an employer in California, you are fully liable for 100% of the amount you collected from your employees that ought to be paid to the IRS. The TFRP may apply to you if these unpaid trust fund taxes cannot be collected right away by the IRS from your business. In order for the TFRP to be assessed, your business does not have to have stopped operating.
Who Can Be Responsible for the 100% Penalty
The TFRP may be assessed against you if you willfully fail to collect or pay the trust fund taxes and if you are responsible for collecting or paying withheld income and employment taxes, or for paying collected excise taxes.
For willfulness to exist, you as the responsible person:
(i) Must have been, or should have been, aware of the outstanding taxes and
(ii) Either intentionally disregarded your legal obligations or were plainly indifferent to its requirements (no evil intent or bad motive is required).
Using available funds to pay other creditors when your business is unable to pay the employment taxes is an indication of willfulness.
You may be considered a responsible person or part of a group of people who has the duty to perform and the power to direct the collection, accounting, and payment of trust fund taxes. As a responsible person you may be:
An officer or an employee (such as a bookkeeper) of a business,
A member or employee of a partnership,
A corporate director or shareholder,
Another person with authority and control over funds to direct their disbursement, or
A member of a board of trustees of a nonprofit organization.
You may be asked to complete an interview in order to determine the full scope of your duties and responsibilities. Responsibility is based on whether you exercised independent judgment with respect to the financial affairs of the business. If the employee’s function was solely to pay the bills as directed by a superior rather than to determine which creditors would or would not be paid, an employee may not be a responsible person.
Figuring the 100% Penalty Amount
The amount of the penalty is equal to the unpaid balance of the trust fund tax. The penalty is computed based on:
(i) The unpaid income taxes withheld, plus
(ii) The employee’s portion of the withheld FICA taxes.
For collected taxes, the penalty is based on the unpaid amount of collected excise taxes.
Assessing the TFRP
If the IRS determines that you are a responsible person, it will send you a letter stating that it probably will assess the TFRP against you. You have the right to appeal its proposal if you do so within 60 days after the IRS delivers the letter. The letter will explain your appeal rights. For a clear outline of the appeals process, see Publication 5, Your Appeal Rights and How to Prepare a Protest if You Don’t Agree. If you do not respond to that letter, the IRS will assess the penalty against you and send you a Notice and Demand for Payment.
Once the penalty is asserted against you, the IRS can take collection action against your personal – not just your business – assets. For example, the IRS can levy your wages or bank account, seize your property or file a notice of federal tax lien.
Avoiding the TFRP
You can avoid the TFRP by making sure that all employment taxes are collected, accounted for, and paid to the IRS when required. Make your tax deposits and payments on time. Additional information on employment taxes can be found in Publication 15, Employer’s Tax Guide.
Assistance is available for this tax problem and others as well. Please call Mitchell A. Port at (310) 559-5259 for a consultation.