Trust Fund Recovery Penalty

In order to better understand how grounds for the imposition of a “trust fund recovery penalty” comes about it is helpful to take a close look at the regulation which gives rise to that penalty, IRC Section 6672(a).

IRC Section 6672(a): Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for or pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.

This is commonly known as the 100% penalty and it is assessed to recover the Trust Funds that were not paid.  “Trust funds” is the term given the money an employer withholds from an employee's paycheck, and that amount includes federal income tax and the employees' share of FICA and Medicare payments. The funds should have been held in trust until paid over to the Internal Revenue Service.

Reporting Withheld Trust Funds to IRS

The IRS may impose the penalty on any person or group of people who have the duty to perform and the power to direct the collecting, accounting and paying of trust funds. This person may be:

• an officer or an employee of a corporation
• a member or employee of a partnership
• a corporate director or shareholder
• a member of a board of trustees of a nonprofit organization, or
• any other person with the authority and control to direct the disbursement of funds.

Bankruptcy No Protection

Unlike income taxes, the Trust Fund Recovery Penalty is not dischargeable in bankruptcy.  Small businesses frequently fail. When that happens, most debts can be discharged in bankruptcy.  The entrepreneur can live on to begin another business in a fresh start.  However, the Trust Fund Recovery Penalty can thwart any efforts to rebuild and start over after the demise of a failed business.  The penalty often must be resolved and often is resolved through an offer in compromise.  The IRS can assess a Trust Fund Recovery Penalty not only against the owners of the business, but also against its accountants or bookkeepers or clerical staff, particularly if they had authority to sign checks. Sometimes IRS Revenue Officers will simply assert the penalty against anyone who signed checks or had the authority to sign checks.

Legal Help for Trust Fund Recovery

A tax attorney can readily help an individual to protest a levy of the penalty and can vigorously defend that person if the penalty is in fact assessed against them.  Sometimes an attorney can isolate valid grounds to have the Trust Fund Recovery Penalty entirely removed months or even years after it was assessed.  The penalty can sometimes be successfully challenged by paying the amount of withheld taxes for one employee for a single withholding tax quarter and then filing a refund claim. IRS often will agree to then remove the penalty.    However, an IRS denial of the refund claim will give rise to an appeal process which can be pursued if necessary in court.