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July 22, 2021

How to Avoid the Trust Fund Recovery Penalty


trust fund

If you own or manage a business with employees, you could be at risk for paying a harsh tax penalty called the “Trust Fund Recovery Penalty.” The Trust Fund Recovery Penalty applies to the Social Security and income taxes businesses are required to withhold from their employees’ wages.

The employer holds these taxes in “trust” on the government’s behalf until they’re paid over since taxes are considered property of the government. The Trust Fund Recovery Penalty is sometimes referred to as the “100% penalty,” as the person liable and responsible for the taxes is forced to pay a penalty of 100% of the taxes due. Because of this, the amounts sought by the IRS when the penalty is applied are often quite large, and the penalty is aggressively enforced by the IRS.

In addition, the Trust Fund Recovery Penalty applies to a broad range of actions and a wide range of people involved in a business, making it one of the more dangerous tax penalties.

We’ve put together a few answers to commonly asked questions that can help you avoid the penalty.

What actions does the penalty apply to?

Any willful failure to collect, truthfully account for, or pay over the Social Security and income taxes that are required to be withheld from employees’ wages can trigger The Trust Fund Recovery Penalty.

Who can be penalized?

Anyone who is “responsible” for collection and payment of the tax may have the penalty imposed on them. This “responsibility” is broadly defined as including any officers, directors, and shareholders of a corporation who are under a duty to collect and pay the tax. It also includes the partners in a partnership, as well as any employee of the business who has such a duty. Under certain circumstances, even voluntary board members of tax-exempt organizations can be subject to this penalty, despite typically being exempt from responsibility. Responsibility has even been extended in some cases to attorneys, accountants, and family members who are close to the business.

The IRS defines responsibility as a matter of status, duty, and authority, and anyone with the power to ensure that the taxes are paid (or not paid) can be held responsible for a lack of payment. 

Oftentimes there is more than one person in a business who may be considered responsible, but each of these people is at risk for the entire penalty. Even if you aren’t directly involved with your business’s payroll tax withholding process, you could become a responsible person if you have the power to pay over withheld taxes and learn of a failure to pay them but choose to make payments to creditors and others instead.

Although taxpayers who are held liable can sue others who were responsible for contribution, they still must pay the penalty and must take this action entirely on their own, since it isn’t part of the IRS’s collection process.

What does the IRS consider to be willful action?

A taxpayer doesn’t need to have overt intent to evade taxes in order for their actions to be considered willful. If a person bends to pressures from (or on) their business and chooses to pay bills or obtain supplies instead of paying over withheld taxes that are due, that would be considered willful behavior. Delegating responsibilities to someone else won’t necessarily shield you from responsibility either, since failing to take care of the job yourself may be considered a willful act.

Don’t risk the penalty

In order to avoid the Trust Fund Recovery Penalty, you need to ensure that you never fail to withhold taxes, and must never “borrow” from withheld amounts under any circumstance. In addition, you should make sure that any funds withheld are paid over to the government on time. 

Questions about making payments? Contact us.

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