Payroll Tax Debt can become a nightmare for a taxpayer who gets behind. In addition to the potential penalties to a corporation, LLC, or partnership for unpaid taxes that we reviewed in our previous blog, there is also the potential for personal liability. Today, we will cover Payroll Taxes and personal liability. When taxpayer’s come into our Richardson TX office with Payroll tax debt, one of our priorities is to minimize their potential this personal exposure.
There are two types of Payroll Funds sent to the IRS (and States):
- Trust Funds – These are the payroll taxes withheld from employees that are remitted to the Treasury and/or States. The Federal Withholdings include the Employees Federal Income Tax withholdings, as well as the employee’s portion of Social Security and Medicare.
- Employer Taxes – Employer’s match of the Social Security and Medicare taxes and Federal Unemployment.
The Trust Funds or Fiduciary Funds are the part of payroll taxes that can become personal liability.
Who Is Responsible?
IRC Section 6672 allows the IRS to recover “trust funds” from any person required to collect, truthfully account for an pay over any tax imposed and who willfully fails to collect such tax or truthfully account for an hand over such tax, or willfully attempts in any manner to evade or defeat any such tax payment. To many, this is confusing, and many are surprised that non-owner employees, can be held personally liable for unpaid payroll taxes of a business.
What would be considered to be willful?
- Person was, or should have been, aware of the outstanding taxes and either intentionally disregarded the law or was indifferent to the consequences.
- Must have been responsible at the time to be liable.
Keep in mind that neither Insufficient funds nor obeying a superior’s orders are considered to be an adequate defense by the IRS.
Who can be deemed responsible?
- Sole Proprietors
- Bookkeepers/Accounting Firms (sign checks/make decisions on payments)
- Lenders/creditors in limited cases
- Parent Companies
The test for responsibility is a functional test that must be met at the time the failure to pay occurred. While the employees Title plays some role, the substance of their role is the most critical factor. For example, a Vice President of Sales, who has nothing to do with making payment decisions or has no knowledge of the payroll problems, may not be responsible, while a VP of Accounting may be responsible.
The functional tests will include questions such as:
- Did the Person have check signing authority?
- Did the Person make decisions on what bills were to be paid?
- Was the Person aware of the non-payment of the Payroll Taxes?
What can a “Responsible Person” be liable for?
Responsible Persons may be held responsible for the trust funds portion of payroll taxes. The IRS can pursue any and all responsible persons, and each is jointly and severally liable for the tax. This liability is known as the Trust Fund Recovery Penalty (TFRP).
For example, a business with two partners (each considered responsible) owes $100,000 in payroll taxes to the government, of which $60,000 are trust funds. The government can collect $60,000 from the business, Partner A, or Partner B but only one time in total. The government will attempt to collect the other $40,000 only from the business.
Single Member LLCs – Starting January 1, 2009, it was determined that a Single Member LLC (SMLLC) will be treated the same as a corporation for purposes of employment taxes in that a Member is not typically responsible for non-trust fund taxes.
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