If an employer fails to properly pay its payroll taxes, the IRS can seek to collect a trust fund penalty equal to 100% of the unpaid taxes from any person who is considered a “responsible person,” (One who is responsible for collecting, accounting for, and paying over payroll taxes); and also willfully fails to perform this responsibility. The IRS will often assess these penalties against any and all persons in the organization who can be considered “responsible persons.”
To determine who a responsible person is, several factors are considered: (1) the duties of the officer as outlined by the corporate by-laws; (2) the ability of the individual to sign checks for the corporation; (3) the identity of the officers, directors, and shareholders; (4) the identity of the individuals who hire and fire employees; and (5), the identity of the individuals who were in control of the financial affairs of the corporation. Other factors include whether the person had access to the company’s books and records, and whether the individual has made personal loans to the company. Other intricacies, and there are many, are beyond the scope of this article.
A responsible person will be found liable under the Code if the IRS can demonstrate that they had either (1) actual knowledge that the trust fund taxes were not paid and the ability to pay the taxes, or (2) recklessly disregarded known risks that the trust fund taxes were not paid. In other words, they knew that the taxes had not been paid, and had access to the funds to pay the taxes, but willfully chose to pay other liabilities instead.
Trust fund taxes are the portion of the payroll tax that is withheld from an employee’s wages; income tax, social security tax, and Medicare tax. Because social security and Medicare are trust funds, an employer has a fiduciary responsibility for properly managing these monies. The portion of payroll taxes that are “matched” by the employer are not trust fund taxes, but are still a tax liability for the company.
For a business having trouble with its cash flows, not paying over these taxes can be the easiest loan to take out, and the hardest loan to pay back. The owners typically figure, “I’m short on money this month, but things will be better next month and I’ll pay the taxes next month.” Next month comes, cash flows are no different, and down the slippery slope the business goes. Maybe the next month is back to normal, but not good enough to pay two months’ worth of payroll tax, so the owner pays last months tax and puts off paying the taxes for the current month. Kiting the payment of payroll taxes is such a common occurrence that the IRS and their algorithms specifically look for these patterns.
If you think that the IRS has no sense of humor when it comes to unpaid income taxes, just wait until you get behind with somebody else’s trust fund monies; especially when those employees have applied for, and received their income tax refunds – of tax money that was never paid in. If you own a company, are behind in your payroll taxes, and take a wage, be careful because if you claim a refund for taxes that were never paid in that is considered fraud. The penalty for civil fraud is 75% of the tax owed. If you are having troubles like this, contact our firm or other competent and licensed tax professional right away so that they can help stop the bleeding and pull you out of this pitfall.