What to Know About the IRS Trust Fund Penalty

When an employer withholds taxes from an employee’s paycheck, the law requires them to act as a trustee for the government. These funds, known as trust fund taxes, include federal income tax, Social Security, and Medicare taxes. They are not the property of the business but are held in trust to be paid to the U.S. Treasury. The Trust Fund Recovery Penalty (TFRP) is a mechanism the Internal Revenue Service (IRS) uses when these funds are not remitted. This penalty allows the IRS to hold individuals personally liable for the unpaid amount, shifting the debt from the business to the people who had control over the funds.

Who is Considered a Responsible Person

The IRS applies a two-part test for personal liability: the person must be “responsible” and their failure to pay must be “willful.” Responsibility is determined by an individual’s status, duty, and authority, not just their job title. A responsible person is anyone with significant control over company finances and the power to decide which bills to pay. This can include corporate officers, directors, shareholders, or employees like a bookkeeper who exercised independent judgment over financial affairs.

An employee who only pays bills as instructed by a superior is generally not considered a responsible person. However, a person cannot escape this designation by delegating tasks to someone else, such as an external bookkeeper, if they ultimately retained the authority to control financial decisions.

Willfulness does not require a bad motive or intent to defraud the government. It is a voluntary and intentional decision to pay other creditors instead of the IRS when the person knew the taxes were due. Using available funds for rent, suppliers, or net salaries while taxes are outstanding is an example of willfulness. Reckless disregard for whether the taxes were being paid can also satisfy this requirement.

The IRS Assessment Process

The assessment process begins with an investigation by an IRS Revenue Officer to identify who meets the criteria of a responsible and willful person. A part of this investigation is the interview, documented on Form 4180, Report of Interview with Individual Relative to Trust Fund Recovery Penalty. During this interview, the officer asks questions to establish an individual’s role and authority over the company’s finances.

Questions on Form 4180 probe into who had check-signing authority, determined financial policy, authorized payroll, and directed payments to creditors. The IRS may also review corporate documents, bank signature cards, and board meeting minutes to corroborate the interview findings.

Once the IRS identifies potentially responsible individuals, it issues Letter 1153, “Proposed Assessment of Trust Fund Recovery Penalty,” via certified mail. This letter specifies the amount and tax periods involved. Included with Letter 1153 is Form 2751, which gives the individual the option to agree to the assessment.

Upon receiving Letter 1153, the individual has 60 days to respond. If they disagree, they have the right to file a formal protest and appeal the decision with the IRS Office of Appeals. Failing to respond within the 60-day window results in the loss of these appeal rights, and the IRS will proceed with assessing the penalty.

Calculating the Penalty Amount

The Trust Fund Recovery Penalty is often called the “100% penalty” because the amount assessed is equal to the total of the unpaid trust fund taxes. The calculation is precise and only includes the money that was actually withheld from employees’ paychecks and held in trust for the government.

The penalty does not cover the employer’s matching share of Social Security and Medicare taxes, nor does it apply to federal unemployment (FUTA) taxes. Those amounts remain a liability of the business entity itself and are not passed on to individuals through this penalty.

The IRS can assess the full penalty against multiple responsible individuals. For instance, if a business failed to remit $50,000 in trust fund taxes and the IRS identifies two responsible persons, both can be held personally liable for the entire $50,000. This creates joint and several liability. However, the agency is only entitled to collect the total tax amount once.

Managing Post-Assessment Obligations

Once the Trust Fund Recovery Penalty is formally assessed, it becomes a legally enforceable personal debt. The IRS will pursue collection with the same tools it uses for other tax liabilities. If the debt is not paid, the agency can file a Notice of Federal Tax Lien against personal property, which can impact credit, or issue levies to seize assets like garnishing wages and bank accounts.

For individuals who cannot pay the full penalty amount immediately, the IRS offers resolution options. One approach is an Installment Agreement, which allows the debt to be paid off through monthly payments. This requires providing financial information to the IRS to determine an affordable payment amount.

Another path for resolution is an Offer in Compromise (OIC), which allows a taxpayer to settle their tax debt for less than the full amount owed. An OIC is only available to those who can demonstrate significant financial hardship. To qualify, an individual must complete a detailed financial disclosure on Form 433-A (OIC) and prove they lack the income or assets to pay the full debt.