Penalties ahead for unpaid employment taxes?

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The Trust Fund Recovery Penalty is often described as one of the largest penalties in the Tax Code. It applies to employers that fail to withhold federal income, Social Security or railroad retirement, and Medicare taxes from their employees’ wages or salaries. These withheld taxes belong to the employees, and are held in trust by the employer until they make a federal tax deposit in that amount. If unpaid trust fund taxes cannot be immediately collected, the TFRP may be assessed against any “responsible person.”

“The TFRP, under Code Section 6672, imposes as a personal liability an amount equal to the total amount of tax willfully evaded, not collected, or not paid over, on those determined to be responsible for collecting, accounting for and paying over to the IRS the withholding taxes and employee share of payroll taxes held in trust,” said Robbin Caruso, partner and co-managing director of the tax controversy practice at Top 100 Firm Prager Metis CPAs.

“The IRS considers ‘responsibility’ to be a function of the person’s duty, status and authority,” she said. “This person could be the owner, a member of the board of directors, officer, an administrator, or anyone who had the authority, apparent or actual, for these duties. It is all based on facts and circumstances.”

“Although this is called a penalty, it is essentially the alternative ability of the IRS to go beyond the business — which many think of as having limited personal liability — to collect amounts due from responsible persons who are considered willful,” she explained. “While the TFRP is not new, it is much more likely to become problematic in times such as this, with the advent of the COVID-19 pandemic, where businesses may be under extreme financial pressure, suffering from loss of revenues.”

Roger Harris agreed. “It’s an easy way to borrow money from the government because they don’t know you’re doing it until, in some cases, it’s too late,” said Harris, the president of Padgett Business Services. “If you’re supposed to be making monthly deposits, until you do your quarterly they don’t know, so you can buy 100 to 120 days easily. It’s always been a problem and the service is aware of it. If you don’t pay your rent or a vendor, they will contact you immediately, but if you take the money due to the government and pay the vendor or landlord it might be months before the IRS contacts you. You always think that you’ll have the problem solved before they contact you. Unfortunately, when that happens you’re just starting a cycle of things. It might be OK if it’s just a one-off, but usually the problem grows and by the time the IRS gets in touch with you it’s too big a problem for a simple solution.”

“It’s not a new problem but the question is, will we see a spike in this because of the pandemic? My guess is that we probably will,” Harris said. “A lot of times business owners don’t understand that they can be assessed personally as the responsible party. Others involved in the business can also be responsible persons — if they have the ability and knowledge to make a payment, and choose not to do it, they can be assessed as well.”

The IRS says the TFRP may be assessed against any person who is responsible for collecting or paying withheld income and employment taxes, or for paying collected excise taxes, and willfully fails to collect or pay them over to the government.

The net of who may be a responsible person is much wider than a mere owner. It may include:

  • An officer or an employee of a corporation;
  • A member or employee of a partnership;
  • A corporate director or shareholder;
  • A member of a board of trustees of a nonprofit organization;
  • Another person with authority and control over funds to direct their disbursement;
  • Payroll service providers or responsible parties within a PSP;
  • Professional employer organizations or responsible parties swithin a PEO; or,
  • Responsible parties within the common law employer (client of PSP/PEO).

“The service has made some strides to speed up making visits to people before the problem gets too large,” said Harris. “The question is how much does it get worse during the COVID pandemic?”

Recent legislation may confuse the situation for some, according to Sean Muller, national practice leader of tax services at Top 100 Firm Weaver.

“The Trust Fund Recovery Penalty only applies to the employee portion of payroll taxes,” he explained. “Therefore, it should not apply to the Social Security deferral provided by the CARES Act, since the deferral only applies to the employer portion of Social Security taxes.”

“One potential risk under the CARES Act is with the Employee Retention Credit, the Paid Sick Leave Credit, and the Paid Family Leave Credit. Similar to the Social Security deferral, these credits only apply to the employer’s portion of Social Security tax,” Muller said. “However, if the credit exceeds the employer’s portion, it can be applied to all other taxes. But if the credit is not properly calculated, a responsible person could run into an issue.”

The statute of limitations on the assessment of the TFRP is generally the later of three years from the due date of the return, without regard to extensions, or three years from the date that the payroll tax return was filed, Caruso noted.

“It is very important that the responsible person understand that the statute of limitations is not running if the payroll tax return has not been filed,” she cautioned. “We encourage businesses to file returns timely so the statute of limitations will be running if the payroll tax return has not been filed. Additionally, the statute will be extended by certain actions, such as the execution of Form 2750, [Waiver Extending Statutory Period for Assessment of TFRP]; the bankruptcy of the responsible person (not of the corporation); or the issuance of IRS Letter 1153 advising of the proposed assessment of the TFRP and the right to request an appeal.”

For taxpayers who enter an offer-in-compromise agreement to lessen the amount they must pay, Caruso warns that all of the elements of the agreement must be kept. “The Court of Appeals for the Fifth Circuit recently [July 7, 2020] sustained a Tax Court decision that the IRS could collect the rest of the liability originally due where a taxpayer neglected to comply with the OIC conditions,” she explained.

In the relevant case, even though taxpayers Edward and Cynthhia Sadjadi had paid the entire amount they had agreed to pay in the OIC, they failed to remain current on their tax payment obligations, thus triggering the IRS levy for the full amount.

On Aug. 8, 2020, President Trump issued executive orders to allow a deferral of withholding, deposit and payment of the employee’s share of Social Security taxes on wages paid during the period from Sept. 1, 2020, through Dec. 31, 2020.

“This deferral is available with respect to any employee whose wages payable during any biweekly period is generally less than $4,000 calculated on a pre-tax basis, and such deferred amounts are not subject to interest, penalties or additions to tax,” said Caruso. “Since this order defers the withholding of the employee’s taxes, the act of an employer following this executive order would not give rise to a situation leading to Trust Fund Recovery Penalty Problems,” she explained.

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Payroll taxes Payroll Tax regulations Tax scams CARES Act
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