Unpaid Payroll Taxes Can Result in Personal Liability
Times are tough, but small business owners should think twice before deciding not to make that next payroll tax deposit. Did you know there is personal and even criminal exposure for not making timely payroll tax deposits? Moreover, a portion of the tax is not dischargeable in bankruptcy.
The Trust Fund Recovery Penalty (TFRP) is a mechanism used by the IRS to collect back payroll taxes. This is known as a Trust Fund Tax because the employer is actually holding the payment “in trust” for the government. In other words, money was collected on behalf of the IRS that was supposed to be turned over to the government. The government views this as their money and failure to turn it over is akin to robbery – you were holding their money and spent it without their permission.
The TFRP can be assessed against the business and any person the IRS finds was both “willful and responsible.” A “responsible” person is usually one that is the owner, officer or director, but can also be someone who was supposed to make the actual payment, such as accountants, bookkeepers and similar persons. The IRS also assumes anyone with signature authority on the business’s bank account is a responsible person. A “willful” person is basically one who was supposed to pay the taxes and chose not to do so for any reason.
Once the IRS determines that there is a potential trust fund recovery penalty, a notice of proposed assessment is sent to any taxpayer against whom it intends to assess the penalty. At this point the taxpayer may sign a form agreeing to the proposed assessment or dispute the proposed assessment by appealing within sixty days of the date of the notice. Additional penalties will apply if the taxpayer does not respond in time.
If the taxpayer protests the proposed assessment, a revenue officer will review the protest and may request further information or determine that the protest is incomplete and return it for correction. The taxpayer has forty-five days to respond to an information request or to return a complete protest. The revenue officer will then review the information and if he or she determines that the assessment should not be changed, a letter is sent to the taxpayer stating that the case will be forwarded to the Appeals Office.
If the taxpayer appeals the proposed assessment, a conference in the Appeals Office is held with an IRS Appeals Officer. The representative will review the case and determine whether the proposed assessment is valid. If the representative determines it is valid, the penalty will be assessed if the appeal was filed within the sixty days, otherwise previous collection activities will be resumed.
Once an assessment is made the taxpayer may contest it again by paying the tax on at least one employee for one applicable tax period and filing a claim for refund with the IRS with IRS Form 843. The taxpayer may also pay the entire tax liability and bring suit in the U.S. District Court or the Court of Federal Claims if a claim for refund has been denied by the IRS. The taxpayer can only file suit for refund if it has been more than six months since a claim for refund was filed, or if a Notice of Disallowance was issued, whichever occurred first. If the taxpayer files for bankruptcy, the IRS can even file a claim in Bankruptcy Court that will not be discharged. Finally, the taxpayer has the option to file an Offer in Compromise with the IRS. It is important to note that certain time frames apply to bringing suit in court and this right can be lost if not filed in a timely fashion. The more taxpayer friendly U.S. Tax Court unfortunately does not have jurisdiction over TFRP cases because the tax is an assessable penalty, not subject to deficiency procedures.
An accepted Offer in Compromise is an agreement between the taxpayer and the IRS to settle the tax liability for less than the full amount owed. The IRS accepts offers in compromise if there is doubt as to the liability, doubt as to the collectability of the liability or a resolution would be in the interest of effective tax administration. If the offer is rejected, the IRS may immediately resume collection efforts, which include freezing bank accounts and seizing funds, seizing other assets or filing tax liens against property.
It is important to note that the IRS will generally exhaust every collection potential and seize most available assets from a taxpayer deemed to be liable for the penalty if they feel the penalty is properly assessed. Further, if the IRS has cause to believe that collection efforts may be thwarted if a taxpayer is given advance notice, it has the ability to immediately freeze assets of a taxpayer. When there are multiple responsible persons, each person is jointly and severally liable for the TFRP. That means that the government is entitled to collect the entire tax, or any portion thereof, from any responsible person it chooses, without regard to degree of fault or ability to pay. Failing to pay taxes or paying taxes late is never a good idea, however, it is especially not recommended with payroll taxes due to the IRS’s viewpoint that the money already belongs to them and that you are merely “holding” it for them, not to mention the personal civil and criminal exposure. Understanding the severe nature of the penalties involved and the potential for criminal liability, it is extremely important that you have a good tax attorney on your side to advocate on your behalf. In fact, certain strategic decisions must be made early on to ensure the full attorney-client privilege, as opposed to the limited protections sometimes afforded to accountant-client communications.