Running a corporation involves a high level of responsibility. Aside from ensuring businesses’ daily operations run smoothly, corporation owners must meet their federal and state tax obligations.
Section 6672 of the Internal Revenue Manual (IRM) stipulates that individuals are responsible for failure to pay employment taxes. Corporations that don’t withhold social security, Medicare, and FUTA taxes are subject to Trust Fund Recovery Penalty (TFRP).
The IRM defines Section 6672 as ‘the authority for TFRP’ and provides guidelines regarding the Taxpayer Bill of Rights and Account & Processing Support.
We’ll cover the essential parts of IRC Section 6672 to help you understand its consequences on corporations and individuals responsible for withholding employment taxes from salaries corporations pay to their employees.
Table of Contents
Ins and Outs of IRC Section 6672
IRC Section 6672 deals with a complex tax issue, which is why fully grasping its implications requires in-depth knowledge of corporate tax laws.
This segment of the IRM references different Internal Revenue Codes, making it more difficult for corporate employees to debunk its meaning.
Consequently, you must be familiar with IRC 3402(a), IRC 3102(a), IRC 7501(a), and IRC 1446 to interpret Section 6672 correctly.
IRC 7501(a) is particularly important for understanding Section 6672 because it states that the funds withheld from the salaries businesses pay their employees are ‘held by the employer in trust for the benefit of the United States.’
The reference to trust made is the IRC 7501(a) is why Section 6672 is referred to as Trust Fund Recovery Penalty.
The section stipulates that the TFRP program allows the government to pierce the corporate veil and reach individuals otherwise protected from corporate tax liability.
Consequently, the IRS can hold employees of S Corporations and all other types of corporations, LLCs, or partnerships responsible for failing to withhold employment taxes.
The government can also assess TFRP to:
- Shareholders.
- Officers.
- Outside entities (in some cases).
The IRS can apply TFRP under Section 3305 of the IRC on lenders or sureties that make direct payments of wages to the taxpayer’s employees.
Understanding Trust Fund Recovery Penalty
In its simplest form, TFRP is a tax collection mechanism. It doesn’t refer to actual penalties that apply to a responsible person who fails to collect employment taxes.
Section 6672 indicates that a responsible person’s liability equals the amount they didn’t collect in taxes. Besides proving that a corporation’s employee is responsible for not collecting employment taxes, the IRS must also prove that the employee has done so willfully.
Willfulness
Section 6672 of the IRM offers little information regarding what constitutes willfulness. Instead, this term is easier to understand from definitions created by the US courts.
Some court rulings define willfulness as a ‘voluntary, conscious, and intentional act of preferring other creditors over the United States.’
The fact that Section 6672 contains only vague references to willfulness further proves that understanding TFRP without extensive knowledge of the US judicial and tax systems is virtually impossible.
However, the document offers guidelines the IRS must follow to determine in a corporate worker willfully preferred other creditors over the United States. The IRS uses the following factors to assess willfulness:
- The responsible person had knowledge of a pattern of noncompliance at the time the delinquencies were accruing.
- The responsible person had received prior IRS notices indicating that employment tax returns have not been filed or are inaccurate or that employment taxes have not been paid.
- The responsible party has taken actions to ensure its Federal employment tax obligations have been met after becoming aware of the tax delinquencies.
- Fraud or deception was used to conceal the nonpayment of tax from detection by the responsible person.
According to numerous court decisions, this term doesn’t necessarily indicate that the responsible person had a criminal motive to avoid paying taxes to the federal government.
Instead, it refers to a voluntary, conscious, and intentional failure to collect, account for and pay employment taxes. Some court rulings even interpret missing monthly tax payments as a willfulness to prefer other creditors over the United States.
Responsible Person
Even though IRC 6672(b) offers a definition of a responsible person, that definition is broad as it applies to a highly positioned corporate employee or shareholder in a partnership or LLC.
This subsection of IRC 6672 defines a responsible person as:
‘A “responsible person” is one who has the duty to perform or the power to direct the act of collecting, accounting for, or paying over trust fund taxes.’
Hence, a Professional Employer Organization, corporate director, LLC member, manager or employee, and Payroll Service Provider can all be considered responsible persons.
Court decisions usually utilize the ability to sign checks, control payments, and halt issuing corporation’s checks to determine if an individual can be considered a ‘responsible person.’
This is far from being the only criteria courts use when establishing responsibility. So all corporate workers with the power to hire or fire employees and control the corporation’s financial affairs can be considered a person responsible for failing to pay employment taxes.
Investigation and Penalty Assessment
The IRS initiates a TFRP investigation by assigning a collections officer to a case. The officer first requests all relevant financial records, such as bank signature cards or canceled checks from a business.
The purpose of this step is to identify the responsible person. If a company declines to provide these documents, an IRS agent can use an administrative summon to acquire them from financial institutions.
After reviewing a company’s financial records, a collections officer issues interview requests with all individuals who could be responsible for the company’s failure to pay employment taxes.
The IRS will issue summons to all individuals that fail to appear for the interview at the scheduled time. All persons considered responsible have the right to an attorney or representative authorized to represent them before the IRS.
A responsible person must fill out Form 4180 during the interview, but doing so without legal counsel isn’t advisable.
This document plays a vital role in the collection officer’s decision to assess TFRP, which is why legal representatives must ensure that it also includes their clients’ written statement that contains their defense against TFRP charges.
Collection Process and Statute of Limitations
The IRS will assess TFRP to responsible persons at the end of the investigation. The penalty amount will depend on the amount of employment taxes a company failed to report to the IRS.
The outcome of the investigation is often negative for a responsible person because collection officers commonly charge individuals with negligible responsibility with TFRP.
Once responsibility and willfulness are determined, IRS agents mail Form 5471 and Letter 1153(DO) to the individual’s last known address. According to Section 6672(a)(2), TFRP cannot be enforceable if Form 5471 and Letter 1153(DO) are sent to some other address.
Individuals who receive these documents from the IRS have sixty days to challenge the TFRP decision by submitting a written protest to the IRS Appeals Office. The complaint should contain substantial evidence that proves the TFRP decision is inaccurate.
Individuals charged with TFRP must pay a ‘divisible’ part of the penalty before attempting to take the matter to court.
However, if the court doesn’t rule in the individual’s favor, they will be responsible for paying the penalty. The IRS doesn’t collect the penalty from the corporation the accountable person was working for, even if the company is still operational.
In addition, if one responsible person pays the full penalty, the IRS won’t abate penalties assessed to other corporation officials responsible for avoiding employment taxes.
Trust Fund Recovery Penalty Statute of Limitations is ‘three years from the date a return is filed or the return’s due date, whichever is later.’
Frequently Asked Questions
A responsible person can use an offer in compromise to settle the penalty assessed for failure to report employment taxes. However, an offer in compromise can’t be utilized to pay income, social security, and Medicare taxes.
This section of the IRC only covers issues punishable by civil penalties, but in some cases failing to pay trust fund taxes can result in criminal charges.
Filing for bankruptcy doesn’t clear TFRP, which means a responsible person still has to pay all trust fund taxes and penalties if they file for bankruptcy.
The IRS can collect TFRP for up to ten years after assessing the penalty to a responsible person. Taxpayers charged with TFRP have the same time to pay this penalty.
Contact a CPA
Filing tax returns on time, withholding payroll taxes, and never borrowing from trust funds you withhold from your employees’ salaries will ensure you won’t have to deal with Trust Fund Recovery Penalties and IRS Code Section 6672.
Call 866-8000-TAX or visit Choice Tax Relief to book a meeting with a CPA that can help you avoid TFRP or represent you before the IRS if you’re facing TFRP charges.
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Author:
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.
