If you operate a small business and have employees, you should be familiar with the rules regarding the collection and payment of trust fund taxes. If you are not careful, you could become personally liable if these taxes are not properly accounted for and paid over to the taxing authority.
Under state, federal and sometimes local law, employers are required to withhold from employee wages the income taxes payable by the employee. The employer collects these taxes as “trustee” for the government. Employers are required to file periodic withholding tax returns and pay over to the taxing authority the withheld funds at regular intervals, sometimes as often as every few days.
Officers and employees responsible for withholding taxes from employee wages and paying them over to the government can incur personal liability for these taxes if in fact they are not properly paid over to the taxing authority. This personal liability arises by virtue of the “100% penalty” imposed by section 6672 of the Internal Revenue Code and similar state legislation. Sometimes referred to as the “trust fund recovery penalty”, the 100% penalty may be imposed on a “responsible person” who “willfully fails” to collect or pay over income taxes withheld from employees.
Who is a “responsible person”? Usually, this is an individual within the employer’s organization having sufficient authority to collect and pay outstanding taxes. A failure to pay taxes is considered “willful” if the responsible person was aware of the unpaid taxes and knowingly used these funds to pay expenses of the business other than the employee tax liability. A struggling business with tight cash flow is the most common scenario for a trust fund tax problem. Such businesses sometimes risk dipping into withheld employee taxes to cover short term operating expenses, on the assumption that the business will turn around and the tax can be paid later. More often than not this is an ill-advised strategy. If the business fails to recover, the officers in charge will be found personally responsible for the taxes and pursued aggressively by the
Our recommendation to small businesses and their owners is to avoid using trust fund taxes for any other purpose at all costs. The penalties are harsh, the
– Kevin Palmer