Understanding the “100% Tax Penalty” that Allows the IRS to Go After Multiple People in a Single Business
When most people think of “trust funds” their minds immediately go to extremely decadent lifestyles equipped with fancy cars, caviar, and private islands, but when it comes to Trust Fund Recovery Penalties imposed by the IRS, the “trust fund” in question is not of the extravagant lifestyle sort.
The IRS Trust Fund Recovery Penalty refers to a penalty assessed against those who were responsible for sending money to the Internal Revenue Service on behalf of someone(s) else, but neglected to do so. In other words, when you work for a company, some of the taxes that come out of your wages are a “payroll tax.” To break this down – payroll taxes are taxes an employer withholds from employees for income tax and FICA (Social Security/Medicare). There are also matching amounts of social security and Medicare taxes due from employers, but those are beyond the scope of this discussion and will be discussed in another blog. Your employer is entrusted with sending what you owe for that payroll tax to the IRS. If they (or whomever is in charge of handling and processing payments at your workplace) fail to do so, they will be penalized through Internal Revenue Code Sec. 7501.
The Trust Fund Recovery Penalty is sometimes referred to as the “100% Penalty” because it is equal to 100% of the unpaid withholding amounts. It does not apply to the employer’s share of social security and Medicare taxes. It is also often referred to as the Civil Penalty – or CIV PEN – because the penalty is a civil one, as opposed to a criminal one. Luckily, because it is a civil penalty, it is usually remedied if the person responsible pays the taxes owed (along with penalties and interests). After that, all is gravy. If, however, the responsible party does not pay those monies after they have been admonished by a Revenue Officer, the IRS has been known to go as far as shutting the business down.
Who is affected by this penalty?
Typically, it is the employers or owners of a company that neglect to forward the withheld taxes on behalf of the employees, but that is not always the case. The penalty could trickle down to anyone (and everyone) who had a hand in the non-payment. That means that the penalty could even be imposed upon office managers, receptionists, etc. as long as they were responsible for making payments and willfully neglected to pay the IRS. For example, let’s say that a certain company “X” was owned by a man named Bob. Now, Bob has an assistant named Sue who handles most of his financial responsibilities (such as paying bills, payroll deposits, paying taxes, etc.). Bob always tells Sue where to direct payments and because she is a compliant employee, she always does as she is told. If Sue was aware that the company had neglected to pay payroll taxes, but still made payments that went toward items that were not to the IRS, she would be held responsible for every dollar that went out that was not paid to the Internal Revenue Service.
According to the law, in order for someone to be held liable for the penalty, they had to have had a duty to collect and pay over the taxes, and willfully neglected to do so. In practice, however, the IRS officers tend to be overaggressive when imposing the penalty in order to avoid the risk of someone getting away. We have often stressed how important it is to retain legal representation when dealing with revenue agents and Trust Fund Penalties are an excellent case in point.
Furthermore, the IRS can impose the Trust Fund Recovery Penalty on more than one person – whatever it takes for them to get their money. At the very least there will always be two parties responsible for the unpaid withholding taxes – the business and the responsible person(s). They cannot, however, collect more than what is owed if they do go after multiple people. So, for instance, if Company “X” owed $100,000 in back withholding taxes and the IRS decided to hold both Bob and Sue accountable they cannot collect $100,000 from each of them. If Bob decides to foot the entire bill himself, the IRS cannot come after Sue for $100,000 also. Once the debt is paid, it is paid in full.
What are my options if the IRS imposes the Trust Fund Recovery Penalty on me?
We will say it again just to make sure it sinks in. First and foremost, you should ALWAYS RETAIN LEGAL COUNSEL. Tax attorneys know the tax laws and IRS handbook and regulations backward and forward – the good ones do anyway – and they are the best people to help guide you toward your best option or if you decide to appeal or contest the matter. Once your attorney is familiar with the details of your case, he or she will then be able to determine which of the options is best for you. Those options are:
- Installment Agreement
Your attorney will set up a payment plan for both the business and the responsible individual(s). The installment agreement set up for each party will not be divided. Each party will be on a payment plan to pay off the total amount. This gets a bit tricky so bear with me. It may appear as if the IRS is doubling, tripling, etc. the debt, but they are not. Once the entire balance is paid off from the multiple installment agreements, then the debt is paid.
- Currently Non-Collectible (CNC) Status
Another viable option is CNC status. This is basically exactly what it sounds like. If you simply cannot pay the debt and still meet your basic living expenses (you will need to substantiate this to prove it), the IRS will put a temporary hold on your debt until you are able to pay. Again, this is a temporary solution and does not absolve the debt. If you qualify for CNC status, your account will be removed from collection actions, but your tax refunds will still be garnished and the IRS can still file a Notice of Federal Tax Lien. Also, penalties and interest will continue to mount until the debt is paid off.
- Offer in Compromise
Another option available is an Offer in Compromise. These are agreements between the taxpayer and the IRS to settle a tax debt for a fraction of what is owed. The agreed-upon amount is usually derived from a calculation which factors in all of the taxpayer’s income and expenses to determine what the taxpayer can pay after all basic living expenses are met. Offers in Compromise are a great way to pay off a looming debt (for less) and put the entire matter behind you so that you can move on with your life.