Trust Fund Penalty | Employment Taxes – A Business Owners Worst Nightmare: Personal Liability for Employment Taxes May 13, 2012Posted by Insight Law Firm in Income Tax, IRS, Tax.
Tags: Back Employment Taxes, Back Payroll Taxes, Civil Penalty, Employment Tax, IRS Employment Taxes, IRS Payroll Taxes, Responsible Person, Trust Fund Penalty, Unfiled 941s, Unpaid Employment Taxes, Unpaid Payroll Taxes
Employers really work for Uncle Sam, collecting the IRS’ taxes through the withholding system. (States with income tax laws also impose wage withholding.) By law, employers make three kinds of payments to the IRS after each payday. The check (or electronic transfer) they send covers (1) the income tax withheld from your paycheck, (2) the Social Security and Medicare tax also withheld, and (3) the employer’s matching Social Security/Medicare payment. The first two items – the withheld portions – are known as the “trust fund” part of the tax because a special statute imposes a trust on those withheld funds until the employer pays them to the IRS. The money doesn’t have to be put in a separate bank account, but it’s automatically deemed “in trust” from the instant your employer withholds it from your pay. In a perfect world, the money is there.
But the world is far from perfect. If the employer just doesn’t pay, or decides to pocket that money, employees get full credit on their taxes, but the IRS is still short the money. So it uses a special weapon thousands of times each year, the Trust Fund Recovery Penalty.
This penalty makes the people who were responsible for the nonpayment personally liable for 100 percent of the money that was withheld but not paid over to the IRS, that is, 100 percent of the unpaid income withheld and Social Security/Medicare tax. (The penalty does not apply to the employer’s share of Social Security/Medicare.)
Of course, the corporation is also liable, and the IRS goes after that primary payor first. But the Trust Fund Recovery Penalty makes the responsible persons “guarantee” the corporation’s payment, at least in part. This penalty is a debt that can follow you for at least ten years, or the rest of your life, whichever comes first. The limited liability you personally enjoy from most corporate debts does not apply against this federal law. On top of that, you cannot discharge this penalty by filing personal bankruptcy, as you can with most personal debts.
This Trust Fund Recovery Penalty can be a major tragedy for the businessperson. Most business owners want to stay in business and prosper, but when money gets too tight, many take a chance by paying the squeaky wheels. The IRS is like a hibernating bear in these payroll tax cases. It wakes up late, sometimes years after the first default, but it also wakes up very hungry and aggressive. On top of that, the longer the default goes on, the easier it is to continue and the harder it is to feel that you can ever catch up.
But you can fight the imposition of this “penalty” (it’s really just a substitute for part of the tax the corporation did not pay) in several ways.The law allows you to do this, even before the IRS officially imposes it. The law in this field is very extensive, mostly through cases tried in the courts. You can argue that you were not truly responsible, that some other person was, that you did not know, and a range of other defenses that are technical in nature but that work if you prove them.
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