The Trust Fund Recovery Penalty | Kathryn Meyer Law PC

Yes, if you were a "responsible person" who willfully failed to collect or pay over taxes withheld from employees. The trust fund recovery penalty under section 6672 of the Internal Revenue Code equals the unpaid trust fund tax, and once assessed it can be collected from your personal assets. Before assessing it, the IRS must send a written notice, Letter 1153, and you have 60 days (75 if the letter is addressed outside the United States) to appeal.

The penalty is how a business tax problem becomes a personal one for owners, officers and sometimes bookkeepers. This page explains who is liable, how the IRS builds the case, and the narrow windows for challenging it. Kathryn Meyer's page on IRS collections and enforcement covers the wider collection process.

What does the penalty cover?

Trust fund taxes are amounts a business holds for the government: income tax withheld from employees' pay, the employees' share of Social Security and Medicare taxes, and certain collected excise taxes. The IRS calls them trust fund taxes because the employer holds the employees' money in trust until it is deposited. According to the IRS, the penalty is computed on:

the unpaid income tax withheld from employees, plus
the employees' portion of the withheld Social Security and Medicare taxes, or
for collected excise taxes, the unpaid amount collected.

The penalty can apply when these taxes cannot be immediately collected from the business, and the business does not have to have stopped operating for it to be assessed.

Who counts as a responsible person?

The IRS describes a responsible person as someone with the duty to perform, and the power to direct, the collecting, accounting for and paying of trust fund taxes. That can include:

an officer or employee of a corporation, or a member or employee of a partnership;
a corporate director or shareholder;
a member of a nonprofit's board of trustees;
anyone else with authority and control over funds to direct their payment; and
payroll service providers and professional employer organizations, people inside them, and responsible people at the client business.

Titles alone do not decide it. The IRS looks at whether the person exercised independent judgment over the business's finances. An employee whose job was only to pay bills as directed by a superior, rather than decide which creditors got paid, is not a responsible person. The statute also exempts an unpaid volunteer board member of a tax-exempt organization who serves in an honorary capacity, takes no part in day-to-day or financial operations and did not know of the failure, unless that would leave no one liable (section 6672(e)).

What makes a failure "willful"?

Willfulness here does not require bad motive. The IRS says the responsible person must have known, or should have known, about the unpaid taxes, and either intentionally disregarded the law or was plainly indifferent to it. It singles out one pattern: using available money to pay other creditors when the business cannot pay its employment taxes is an indication of willfulness. In practice, that can mean paying rent or suppliers while payroll deposits wait.

How does the IRS build the case?

Stage	What happens	Source
Interview	A revenue officer interviews potentially responsible people and records it on Form 4180, in person or by phone; the form is not mailed out to be filled in beforehand	IRM 5.7.4
Records	Before contacting banks or other third parties for records, the officer must send potentially responsible people an advance notice (Letter 3164-A)	IRM 5.7.4
Proposal	Letter 1153 and Form 2751, showing the proposed penalty for each quarter, delivered in person or by certified mail	IRC 6672(b); IRM 5.7.4.7
Appeal window	60 days from the letter (75 if addressed outside the United States) to protest to Appeals	IRS TFRP page
Assessment	If you do not respond, the penalty is assessed and you receive a notice and demand for payment	IRS TFRP page
Collection	The IRS can file a lien against you and levy or seize personal assets	IRS TFRP page

Section 6672(b) requires the preliminary notice to precede any notice and demand by at least 60 days. Form 2751 is the agreement form; the IRM notes that signing it does not by itself give up your appeal rights while the response period is still open. If a representative signs for you, the IRM requires a Form 2848 that specifically lists the trust fund recovery penalty, Form 2751 and each period; see how a tax attorney represents you before the IRS.

How do you challenge the penalty?

The best opportunity is the 60-day window after Letter 1153. A protest goes to the Independent Office of Appeals and follows Publication 5: if the total for each period is $25,000 or less you may make a small case request; otherwise a formal written protest is required. A protest addresses what the IRS must establish: responsibility, willfulness and the amount for each quarter.

Missing that window costs more than time. In a later Collection Due Process hearing, section 6330(c)(2)(B) lets you dispute the underlying liability only if you did not receive a notice of deficiency or otherwise have an opportunity to dispute it. The IRM asks revenue officers to document how Letter 1153 was delivered, noting that the record may later help show that the person is not entitled to another opportunity to contest the penalty. Publication 1660 sends a proposed trust fund penalty to the Publication 5 protest procedure rather than the Collection Appeals Program; the collection appeal routes are compared in Collection Due Process or the Collection Appeals Program.

After assessment, the remaining route is a refund suit in a U.S. District Court or the Court of Federal Claims. Section 6672(c) adds a way to pause collection during that fight: within 30 days after notice and demand, pay at least the minimum amount needed to start a court case, file a refund claim for it, and post a bond of 1.5 times the rest of the penalty. To keep that pause, you must sue within 30 days after the claim is denied. The general claim and suit deadlines are in how long you have to claim a tax refund.

What if more than one person is liable?

The IRS can propose the penalty against several people for the same unpaid tax. Under section 6672(d), a person who pays more than their proportionate share can recover the excess from the others who are liable, but only in a separate lawsuit, not inside the government's collection case. The notice also matters for timing: section 6672(b)(3) keeps the IRS's assessment period open until at least 90 days after the notice is mailed or delivered, or 30 days after Appeals makes a final determination on a timely protest.

How do you avoid it?

The IRS's answer is simple: collect, account for and deposit employment taxes when they are due. A business that has fallen behind should treat current deposits as a priority, because late deposits also carry their own failure-to-deposit penalty, discussed in whether IRS penalties can be removed. Businesses that use contractors face a related employment tax risk, covered in what happens in an IRS worker classification audit.

Most trust fund problems start with a missed deposit; the schedules a small employer must follow are set out in when a small law firm has to deposit payroll taxes.

What changes the answer

How payments are applied. Under IRM 5.7.4, undesignated payments on a period go first to the non-trust fund portion (such as the employer's share of social security and Medicare tax), then to the trust fund portion, then to fees and penalties. A voluntary payment with a specific written designation made at the time of payment is applied as designated, so a business can direct money to the trust fund taxes that drive personal exposure.
Involuntary collections. Money taken by levy is an involuntary payment and cannot be designated.
Collectibility. The IRM requires a collectibility determination for each person found responsible and willful; the penalty may be recommended against some and not asserted against others.
Your actual authority. Signing checks only at someone else's direction is different from deciding which creditors get paid.
Knowledge and timing. Willfulness turns on what you knew or should have known when other creditors were paid.
Volunteer board service. Unpaid honorary board members of tax-exempt organizations are protected in the circumstances section 6672(e) describes.

For example: two owners, one unpaid quarter

For example, imagine a small company with two co-owners. One handles operations; the other signs checks, reviews the bank balance weekly and decides which bills are paid. During a cash shortage the company pays rent and its main supplier but not its payroll deposits for one quarter, leaving $40,000 of withheld income tax and employee social security and Medicare tax unpaid. After Form 4180 interviews, the revenue officer could propose the penalty against the check-signing owner, whose authority and knowledge point to responsibility and willfulness, and possibly against the other owner depending on what each knew and controlled. Letter 1153 would start the 60-day protest window. If the company then sends a voluntary payment with a written designation to that quarter's trust fund taxes, the trust fund balance, and the penalty exposure, goes down. This is a hypothetical, not a real case.

Common mistakes with the trust fund penalty

Treating payroll taxes as a loan from the government. Paying other creditors first is the IRS's leading sign of willfulness.
Going into the Form 4180 interview unprepared. The answers become the core of the IRS's case.
Sending undesignated payments. Without a written designation they go to the non-trust fund portion first.
Letting the 60 days pass. That window is the main chance to contest the penalty before assessment.
Assuming a payroll company carries the liability. Responsible people at the client business can still be liable.

What to do this week

Find out which quarters are unpaid and how much of each is trust fund tax.
If Letter 1153 has arrived, calendar the 60th day from its date (75 if addressed abroad).
Make current deposits on time, and add a written designation to any voluntary payment on old quarters.
Gather bank signature cards, check registers, payroll records and the business's organizational documents.
Write down who decided which bills were paid, and when you learned the deposits were missed.
Arrange representation before any Form 4180 interview, with a Form 2848 that lists the penalty and periods.

Frequently asked questions

Does the penalty cover the employer's share of payroll taxes?

No. It covers the trust fund portion: income tax withheld and the employees' share of social security and Medicare tax, plus certain collected excise taxes.

Does the business have to close first?

No. The IRS says the business does not have to have stopped operating for the penalty to be assessed.

Can you be liable if you were only an employee?

Possibly, if you had authority over which bills were paid. An employee who only paid bills as directed by a superior is not a responsible person, according to the IRS.

Can a payment plan cover the penalty?

Yes. Once assessed, it is collected like other personal tax debts, and the options are compared in IRS payment plan options.

Does the penalty affect an offer in compromise for a married couple?

It can. When spouses have joint debts and one also owes a separate trust fund penalty, each files a separate offer; see whether you qualify for an IRS offer in compromise.

Does this reach a law firm owner who pays herself a salary?

It can. A firm that elects S corporation status pays its owner a W-2 salary, as Tax-Smart Lawyering explains, so income tax and the employee share of Social Security and Medicare are withheld from the owner's own pay and must be deposited like any other employee's. The firm's Annual Tax Health Checkup includes a payroll tax compliance check.

How long can the IRS collect it?

Generally 10 years from assessment, like other tax debts; see how long the IRS has to collect a tax debt.

Getting help before you sit for the interview

What you say in the Form 4180 interview, and what you do in the 60 days after Letter 1153, shape the whole case. Kathryn Meyer spent more than two decades in the IRS Office of Chief Counsel and helps business owners and officers respond to trust fund recovery penalty investigations. To discuss a proposed penalty, contact the firm or call (571) 560-8674.

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