It’s common knowledge that the IRS is understaffed and lacks the resources to effectively assess and collect all taxes owed. But when it comes to payroll taxes, don’t underestimate the IRS. Here’s why.
The moment an employer cuts a paycheck to an employee, the taxes withheld from that paycheck are no longer the property of the business. At that point, the employer is acting as an agent who is responsible for remitting the withheld taxes to the IRS on behalf of the employee. These taxes, which include Federal income tax, Medicare tax, and Social Security tax, are also known as Trust Fund taxes because the employer is holding these taxes owed by your employees in trust.
What’s the penalty for not paying payroll taxes?
The Trust Fund Recovery Penalty (TFRP) is 100% of outstanding payroll taxes withheld but not paid. To make it worse, interest is also charged, so the amount owed will only continue to grow if not paid promptly.
Who is responsible for paying the TFRP?
The IRS has the power of law behind them to collect these taxes from anyone deemed to be a responsible person. A responsible person is defined as a person who:
- Is responsible for collecting or paying withheld income and employment taxes, and
- Willfully fails to collect or pay them.
The responsible person has been defined broadly, but the IRS generally starts with the people who have authority to sign checks. Next, they will look to see who had the power to decide which bills should be paid and which should not be paid.
A responsible person demonstrates willfulness when they’re aware (or should have been aware) that payroll taxes are not being paid, and intentionally ignores the problem. Paying other vendors instead of paying payroll taxes is enough to demonstrate willfulness.
The IRS can charge multiple people, including the owner of the company, shareholders, board members or anyone else who has the authority to decide which bills to pay. In at least one case, the IRS even held the former owner of a company liable when the buyer of his company neglected to pay payroll taxes.
What does the IRS do when they find a responsible person?
When the IRS identifies a responsible person, the IRS has the rule of law behind it to collect the unpaid taxes from whatever source they find – bank accounts, retirement accounts, Social Security benefits, etc. In some situations, the business may be shut down and the assets auctioned off to the highest bidder.
The IRS has ten years to collect the penalty, and it cannot be discharged in bankruptcy. In extreme cases, this may lead to criminal charges, with a potential for a fine of up to $10,000 or five years in prison, or both.
How to avoid the TFRP?
The best way to avoid the TFRP is to simply pay your payroll taxes promptly, even if you have to borrow the money. Even credit card debt would ultimately be less expensive than having to deal with the IRS on this issue. And when in doubt, hire a payroll service provider.