Trust Fund Taxes Explained

Internal Revenue Code Section 6672 liability is referred to as the “Trust Fund Recovery Penalty” or “Civil Penalty” and is the legal basis for the federal government to collect “trust fund” taxes. In the context of employment taxes, the term “trust fund” taxes refer only to taxes withheld from employees for the payment of federal income tax and one-half of the Federal Insurance Contributions Act (FICA) taxes. Such taxes are reported on the Form 941 tax return that is filed by an entity with W2 employees on a quarterly basis and reports the gross wages paid, the federal income tax withheld, the sum of employer’s and employees’ FICA liability, and the deposits paid. After the deposits (if any) are accounted for, the taxes still owing are to be paid with the return. The unpaid balance due from these taxes may be the subject of a Section 6672 assessment.

Section 6672 allows the IRS to collect the unpaid trust fund tax liabilities of corporations and other types of limited liability entities from the personal assets of those persons who were responsible for the non-payment of such taxes to the government. Thus, the veil of the entity would not protect the income and assets of the individual from collection of a Trust Fund Recovery Penalty assessment.

The factual pattern is usually one wherein the entity is suffering financial strains and is unable pay creditors used by the entity for the purpose of remaining operational. Therefore, the money to be deposited for the purpose of the Form 941 debts are paid to the non-IRS creditor. When the financial strains of the entity continue, the deposits for the Form 941 debt are not returned and the Form 941 debt is incurred.

Trust fund deficiencies may be assessed against several persons for the same tax period liabilities owing. The policy permitting joint and several liability is to assert the penalty for collection purposes and allow the individuals to dispute the collection of the penalty assessment among themselves. However, the IRS cannot collect more trust fund taxes than are owed by the business.

Generally, a Section 6672 assessment will be assessed when:

1. The individual was a responsible person (someone who has the status, duty and authority over the financial decision-making) within the liable entity; and
2. The individual willfully failed to collect, truthfully account for, and pay over trust fund taxes (by knowingly paying other creditors while the trust fund taxes were due to the IRS).

The determination of who is a responsible person has been defined by administrative rulings and case law, not the Internal Revenue Code. Responsibility attaches when a person has the authority to decide which creditors to pay and when to pay them (or not pay them). Thus, the test is one of control of the payment responsibilities of the entity and not one of title.

The element of willfulness has been defined by case law and the Internal Revenue Manual, not the Internal Revenue Code. Willfulness for Section 6672 purposes merely requires a voluntary, conscious, and intentional decision not to remit funds properly withheld, to the government.

Internal Revenue Manual Section 5.7.5.1 reads that the Trust Fund Recovery Penalty “will normally not be assessed when the likelihood of successful collection is minimal.” Therefore, in practice, the determination of whether a Trust Fund Recovery Penalty assessment should be made is a three element test that includes potential collectability, when Section 6672 is read together with Internal Revenue Manual Section 5.7.5.1.

The IRS generally has three years to assess the Trust Fund Recovery Penalty. Civil Penalty assessments are usually investigated and proposed by a Revenue Officer in the IRS Collection Division. If a Trust Fund Recovery Penalty investigation cannot be avoided by resolving the outstanding payroll liabilities, the Revenue Officer will normally examine the tax returns, bank records, signature cards, Articles of Incorporation, Bylaws, canceled checks, corporate minutes and resolutions of the entity to establish the responsibility and willfulness elements needed for assessment.

Revenue Officers will also (attempt to) complete an interview of individuals who may have knowledge of the entity’s decision making processes and financial condition. Revenue Officers will then (attempt to) complete Form 4180 interviews with the potential targets of the Trust Fund Recovery Penalty. The Form 4180 interview is designed to elicit admissions that a Section 6672 assessment is warranted.

After the Revenue Officer’s recommendation for assessing a Trust Fund Recovery Penalty is approved by the Revenue Officer’s group manager, a sixty-day letter is issued to the taxpayer notifying the individual of the proposed assessments. After receiving the sixty-day letter, a taxpayer has two options to dispute the assessment of the Trust Fund Recovery Penalty: pre-assessment or post assessment appeal. Interest will not accrue if the appeal is made before the penalty is assessed. If the sixty days have expired without a response by the taxpayer, the Revenue Officer will assess the penalty. Collection efforts are pursued by the IRS when the taxpayer fails to respond to the 60-day letter and the penalty is assessed. A resolution to the assessments may be pursued after the merits of the Trust Fund Recovery Penalty have been resolved.

The attorneys at Montgomery & Wetenkamp can assist taxpayers in resolving their tax headaches. For more information regarding Trust Fund Recovery Penalties or other tax issues, contact Montgomery & Wetenkamp at (800) 454-7043 or mwattorneys@mwattorneys.com.