The Internal Revenue Code requires employers to withhold from wages and pay over to the government employment taxes at specified intervals. Because funds withheld from employee wages are not property of the employer but instead are earmarked for the government, they are commonly known as “trust fund taxes”. Such funds are held “in trust” by the employer to be paid to the Treasury at a later date.
For purposes of collecting and paying over trust fund taxes, the employer is deemed to be the equivalent of a trustee. As we will see, the IRS does not take kindly to non-payment of trust fund taxes by employers.
Many small businesses are run on a shoestring and, more often than not, are undercapitalized. The temptation exists during times of temporary cash shortage to defer paying over withheld trust fund taxes, instead using those funds to pay creditors of the business in the hope that the cash crunch will be alleviated. This is usually a poor strategy, however, resulting in a trust fund tax deficit. When this happens, the IRS can get particularly nasty.
Section 6672 of the Internal Revenue Code imposes personal liability on responsible officers or employees for 100% of unpaid trust fund taxes, thus the term “100% penalty”. When the employer fails to pay withheld income or social security taxes, the IRS quickly begins to investigate which person or persons have the legal responsibility for paying over these taxes. The investigation can include any officer, shareholder, agent or employee under a duty to withhold and pay over the tax during the period of non-payment. The IRS has many weapons at its disposal, and can summon bank records, employment tax returns, cancelled checks and other business records to determine who is a “responsible party”. Typically, the IRS will assess the 100% penalty of Section 6672 against the corporate treasurer, as well as any person who has signed the company’s employment tax return or tax payment checks previously sent to the Internal Revenue Service. In addition, a corporation’s president and other executive officers are often targets of the 100% penalty.
Note that the 100% penalty may be assessed simultaneously against multiple individuals, even though the penalty can be collected only once.
Once assessed, the 100% penalty can be collected by placement of a tax lien on the real property of the responsible party, as well as IRS levy on wages and other personal property. The collection powers of the IRS can be awesome once a tax lien is obtained. What can you do to avoid the wrath of the IRS in this area? Consider these tips:
- Avoid the temptation of “borrowing” trust fund taxes to pay creditors in the first place. These are not funds of the business and are not available for borrowing.
- Establish a clear written policy on payment of trust fund taxes and limit the authority to sign employment tax returns and payment checks to a single individual.
- Limit signature authority on bank signature cards to a single officer if possible.
- Contact your attorney immediately in the event of a problem with payment of trust fund taxes or receipt of a “Proposed Assessment of 100% Penalty from the IRS”.
Section 6672 and the 100% penalty are serious and powerful weapons used by the IRS to enforce trust fund tax liability. The liability for these payments is not discharged in bankruptcy – they will follow a person to his or her grave!
If you do incur a trust fund tax problem, remember the cardinal rule: speak to your accountant and your attorney, but politely decline questions or interview requests from the Internal Revenue Service. Many times, the Service makes its determination of personal responsibility based on such contacts and inquiries, and there is little you can say or do that will help your case. Play it safe and contact your trusted advisors first.
— Kevin Palmer