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This is the personal blog of Sterling Olander, Certified Public Accountant and Attorney at Law. For over five years, I have worked as a tax professional helping clients with tax mitigation strategies, tax controversies, business transactions, wealth preservation structures, tax-exempt organiations, and estate plans.

I write about any legal, tax, or technological information that I find interesting or useful in serving my clients. All ideas expressed herein are my own and don't constitute legal or tax advice.

IRS Notice 784 - Trust Fund Recovery Penalty

As mentioned in a previous post, the IRS pays out tax refunds (often constituting amounts an employer has withheld from an employee's paycheck in excess of that employee's income tax liability) before verifying if the employer has actually withheld those amounts or paid them to the IRS. This is a flawed method and helps explain why the IRS is extremely concerned that employers remit these withheld taxes, as well as social security and Medicaid taxes, to the IRS.

One enforcement mechanism is the Trust Fund Recovery Penalty (TFRP), which is described IRS Notice 784, which is referenced in the IRS's website and current Internal Revenue Manual. Since Notice 784 effectively explains the TFRP but does not appear to be generally available on the web, I quote it here:
Could You be Personally Liable for Certain Unpaid Federal Taxes?

If you are an employer, you must withhold federal income, social security (or railroad retirement), and Medicare taxes from your employee’s wages or salaries. If you provide communication or air transportation services, you also may have to collect certain excise taxes from people who paid you for the services. (Get Pub. 510 for more information on excise taxes.) These taxes are called trust fund taxes and must be paid to the Internal Revenue Service through tax deposits or as payments made with the applicable returns.

The trust fund recovery penalty. – If trust fund taxes willfully aren’t collected, not truthfully accounted for and paid, or are evaded or defeated in any way, we may charge a trust fund recovery penalty. This penalty is equal to the amount of the trust fund taxes evaded, not collected, not accounted for, or not paid to IRS. We also charge interest on the penalty.

Who has to pay the penalty? – The trust fund recovery penalty may apply to a person or persons IRS decides is responsible for collecting, accounting for and paying the trust fund taxes and who acted willfully in not doing so. If IRS can’t immediately collect the taxes from the employer or business, we will decide who the responsible person or persons are and who acted willfully.

“Willfully” means voluntarily, consciously, and intentionally. A responsible persons acts “willfully” if this person knows that the required actions are not taking place for any reason. Paying other business expenses instead of trust fund taxes is considered willful behavior.

Any person who had responsibility for certain aspects of the business and financial affairs of the employer (or business) may be a responsible person. A responsible person may be an officer or employee of a corporation, or a partner or employee of a partnership. This category may include accountants, trustees in bankruptcy, members of a board, banks, insurance companies, or sureties. The responsible person can even be another corporation, a volunteer director/trustee, or employee of a sole proprietorship. Responsible persons may include those who direct or have authority to direct the spending of business funds.

If we charge you this penalty, we may take your assets (except exempt assets) to collect the amount owed.

Avoid the penalty. – You can avoid the trust fund recovery penalty by making sure that all taxes are collected, accounted for, and paid to IRS when required. Make your tax deposits and payments on time. IRS employees are available to assist you if you need information on tax deposits and payments. You may telephone the IRS tax information number in your area for help. Pub. 937, Employment Taxes and Information Returns, Pub. 15, Employer’s Tax Guide, and Form 941, Employer’s Quarterly Federal Tax Return, are also helpful and available from IRS.
Source: Bloomberg BNA, Tax and Accounting Center, links added by me.