What You Need to Know About the Trust Fund Recovery Penalty (TFRP)
It’s easy to feel overwhelmed by tax laws, especially when they involve business finances. One penalty that can be particularly concerning is the Trust Fund Recovery Penalty, often shortened to TFRP. This penalty isn’t about your personal taxes—it’s about a business’s unpaid payroll taxes and can affect individuals involved with the business. Let’s break it down and see what you need to know.
What are Trust Fund Taxes?
First, let’s talk about “trust fund taxes.” When a business pays its employees, it’s also required to withhold certain amounts from their paychecks for taxes. This includes federal income tax, social security tax, and Medicare tax. These withheld taxes aren’t the business’s money. Instead, it is held “in trust” by the business until they are sent to the IRS. This is why it is often referred to as the “trust fund” portion of payroll taxes.
Understanding the Trust Fund Recovery Penalty (TFRP)
The TFRP is a penalty that the IRS can impose on individuals who are considered responsible for collecting, accounting for, and paying these trust fund taxes, but didn’t. It’s a personal liability. This means the IRS can go after your personal assets, not just the business assets, to recover what’s owed.
Why Does the TFRP Exist?
The TFRP exists to ensure that payroll taxes are properly paid. The IRS recognizes that some business owners or managers may be tempted to use withheld employee taxes for other business expenses, especially during difficult financial times. To prevent this, the IRS holds individuals personally responsible and liable for these taxes.
Who is a “Responsible Person”?
This is the key point: who does the IRS consider a “responsible person”? It’s not always just the business owner. The IRS looks at who has the power and authority to make decisions about the business’s finances, including decisions about which bills get paid. This could be:
- Owners: Sole proprietors, partners, or corporate officers.
- Managers: Anyone with significant authority over finances.
- Accountants: If they have check-writing authority or control over payments.
- Board Members: If they exert significant influence over financial decisions.
- Other Employees: If they have a significant degree of authority and control over financial decisions of the business
More than one person can be considered a responsible person within the same business. The IRS will look at who had the actual authority and control over the funds and decisions. The title is not the deciding factor, but rather it is their ability to control the financial actions.
How Does the IRS Determine Responsibility?
The IRS will look at several factors to determine who qualifies as a responsible person, such as:
- Who has the power to sign checks, or had access to bank accounts.
- Who hired and fired employees.
- Who had control over paying the business’s bills.
- Who had the authority to direct financial management.
How the TFRP is Calculated
The TFRP is equal to 100% of the unpaid trust fund portion of the payroll taxes (i.e., income tax, social security, and medicare taxes). It does not include the employer’s portion of FICA or federal unemployment (FUTA) taxes.
Let’s say a business withheld $10,000 from employees’ paychecks for federal income tax, social security tax, and Medicare tax but failed to send it to the IRS. The TFRP for the responsible individual would also be $10,000.
How Does the IRS Pursue the TFRP?
The IRS will initially try to collect unpaid payroll taxes from the business itself. If the business can’t pay, the IRS may then investigate the individuals responsible for the unpaid taxes. They will investigate and interview and determine who meets the criteria for a responsible person.
Once they decide who they are going after, they will send a notice to each of the identified individuals. This notice will propose that they are liable for the TFRP. They also have the opportunity to appeal the decision. The individuals can appeal within the IRS, but also in federal court.
If the appeal process is not successful, the IRS can then pursue the TFRP against these individuals. They may take various collection actions, including:
- Levying bank accounts.
- Garnishing wages.
- Placing liens on assets.
Avoiding the Trust Fund Recovery Penalty
The best way to avoid the TFRP is to ensure that all payroll taxes are paid on time and in full. Here are some tips:
- Stay Organized: Maintain meticulous records of all payroll transactions.
- Set Aside Funds: Set aside the amount of withheld taxes each pay period into a separate account. This helps ensure the money is available when the time comes to pay.
- Pay on Time: Schedule tax payments to be made regularly and make sure to pay on time to avoid penalties.
- Seek Professional Help: If you’re unsure about your obligations, consult a tax professional or accountant specializing in payroll taxes.
- Communicate: If you are having financial difficulties, don’t ignore your responsibilities. Communicate with the IRS and develop a payment plan. The IRS is more willing to work with taxpayers who are proactive and make an effort to meet their tax obligations.
- Don’t Delay Payment: Do not use payroll taxes for other expenses. The IRS takes this very seriously, and you may be at greater risk of being considered a responsible party.
What to do if you Receive a TFRP Notice
If you receive a notice from the IRS proposing TFRP against you, do not ignore it. The first step is to understand exactly what the notice is alleging. Consult with a tax professional who can review your specific situation and your rights. If you believe the IRS is wrong, you will have the opportunity to file an appeal.
Common Mistakes and Misconceptions
- Thinking Only Owners are Liable: Remember that anyone with significant control over finances can be a responsible person.
- Ignoring the Notice: Ignoring an IRS notice about TFRP will not make the problem go away; it will likely only make it worse.
- Believing it’s the Business’s Problem: The TFRP is a personal liability, and your assets can be at risk.
- Not Paying on Time: Failing to pay payroll taxes on time is one of the biggest reasons for TFRP, so always be current.
- Assuming Ignorance is Bliss: Not knowing you are a responsible party does not absolve you of the consequences of a TFRP assessment.
- Thinking you are not in control: even if you are a lower-level manager, or have a certain title, if you have control over the finances, then you are at risk of being a responsible party.
The Bottom Line
The Trust Fund Recovery Penalty is a significant risk for anyone involved in managing a business’s finances. Understanding how the TFRP works and taking proactive steps to pay payroll taxes on time is crucial. If you’re unsure about your situation, consult with a tax professional to ensure you comply with all tax laws and to avoid significant and expensive penalties. Don’t let this tax trap catch you unaware.