The trust fund recovery penalty: when a business tax becomes yours

What it covers, and what it does not

Only the trust fund portion: income tax withheld from employees, and the employees' share of social security and Medicare. Not the employer's matching share, not the penalties on the business, not the interest that accrued against the business.

So the personal assessment is smaller than the business balance, sometimes substantially. Working out the trust fund portion of each quarter is the first thing to do, because it is the number that actually matters to the individuals and it is not the number on the business's notices.

Interest runs on the penalty from the date it is assessed against you. And it is not, in practice, a penalty at all in the ordinary sense — it is a collection device that moves the trust fund money from the business to the people who decided not to pay it over.

Responsible, and willful

Both are required, and both are broader than people expect.

A responsible person is someone with the duty and the authority to collect, account for and pay over the tax. Courts look at function rather than title: check-signing authority, control over which bills get paid, authority to hire and fire, involvement in day-to-day financial management, ownership, and a role in the decisions that determined who was paid. A bookkeeper following instructions is generally not responsible. A bookkeeper who decided which creditors were paid may be. An owner who had authority and did not exercise it may still be.

Willfulness does not require a bad motive, and this is the part that surprises people most. It means knowing the taxes were due and unpaid, and paying other creditors instead. Paying employees, suppliers and rent to keep a struggling business alive is the classic case, and it meets the test. Reckless disregard — being aware of a risk the taxes were unpaid and not checking — also meets it.

The genuine defenses are correspondingly narrow: that you had no authority over payment decisions, that you did not know and reasonably could not have known, or that funds available after you learned were encumbered in a way that left no discretion.

The interview and the appeal

The investigation usually starts with a Form 4180 interview. It is a structured questionnaire covering exactly the factors above, and the answers are the primary evidence in any later dispute.

It is worth understanding before it happens, rather than during. The questions about signature authority, about who decided which creditors were paid, and about when you first knew the deposits were being missed are the ones the determination turns on. Answers given casually are relied on afterward.

Letter 1153 follows with the proposed assessment and 60 days to protest to Appeals. That protest is the main opportunity, because it is heard by a function that weighs the hazards of the government's position rather than by the officer who built it.

After assessment, the remaining route is to pay the tax for one employee for one quarter — the penalty is divisible, so this is a small amount — file a refund claim, and sue when it is denied. That works, and it is expensive.

More than one person can be assessed

The IRS may assess the full trust fund amount against each responsible person. It collects the total only once, but it can pursue each of them for all of it, and it commonly assesses several people for the same quarters.

There is a statutory right of contribution between people assessed for the same liability, which is enforced between them rather than through the IRS.

The practical consequences are worth stating. Payments made by the business should be designated to the trust fund portion where possible, because that is the part that follows individuals — the IRS applies undesignated payments to its own advantage. And where several people are exposed, their interests are not identical, which affects who can sensibly advise whom.

Where this comes from

The statutes behind this page, so you can check any of it rather than take it on trust.

IRC §6672(a)

Any person required to collect, account for and pay over tax who willfully fails to do so is liable for a penalty equal to the total amount not paid over.

IRC §7501

Withheld amounts are held in trust for the United States — the source of the obligation.

IRC §6672(b)

Requires notice at least 60 days before assessment, and the right to protest.

IRC §6672(d)

Contribution rights between multiple persons assessed for the same liability.

IRC §6501(a)

The assessment period, which for this penalty generally runs from the filing of the related employment tax return.