How Does the IRS Determine Responsibility for Unpaid Payroll Taxes?

The Internal Revenue Code is notoriously complex, particularly for rules governing business taxes. It is easy for business owners to run afoul of the IRS when trying to calculate and pay its payroll taxes.

All employers are required collect and withhold income and social security taxes from their employees' paychecks. See IRC Sections 3101 and 3102 (Federal Insurance Contributions Act (FICA) taxes), 3401-3406 (income taxes). The employers are also required to file quarterly reports of taxes withheld (IRS Form 941) and to make federal tax deposits (FTDs).

Civil penalties and interest are imposed if the employer fails to file returns or to file them timely or to pay over all or the correct amount of employment taxes. See IRC Sections 6651(a)(1), 6656(a), (b). If the employer who owes these taxes has no assets, the IRS is unable to collect the tax or the penalties and interest from that employer. But despite this fact, the employees still get credit for the amount of income and FICA taxes withheld, even if employer pays never turned over the withheld taxes to the government. See IRC Sections 31, 3102(a). Similarly, where an employer has withheld FICA and withholding taxes but failed to pay them to the IRS, the employee is credited with the amount withheld; and if the government does not recover this tax from the employer or employer's responsible person, the tax is lost. For this reason, the IRS may get especially aggressive in its collection efforts of payroll taxes.

If an employer fails to turn over the withheld taxes to the government, the IRS has the power to impose the Trust Fund Recovery Penalty (TFRP) against certain individuals who are determined to be "responsible persons" of the employer. The amount of the liability is equal to the amount of the delinquent trust fund taxes which consist of the employee's portion of the FICA taxes and all of the withholding taxes. The Trust Fund Recovery Penalty is a collection device; it is a method by which the Internal Revenue Service assesses personal liability against an individual and "pierce the corporate veil" without the necessity of any prior judicial determination.

The determination of whether an individual or individuals will be liable for the Trust Fund Recovery Penalty is a two-part test. The first part is whether the individual(s) is a responsible person, as discussed above, and the second part is whether that person failed to perform the required acts "willfully."

Responsible Person

A person subject to the Trust Fund Recovery Penalty includes "an officer, or employee of a corporation, or member or employee of a partnership, who ... is under a duty to perform the act in respect of which the violation occurs." See IRC Section 6671(b). A person other than a corporate employee or officer may be found to be a responsible person for purposes of the penalty. On the other hand, it is not necessary to assess a Trust Fund Recovery Penalty against a sole proprietor. In sole proprietorships, the individual owners are fully liable for the full amount of the taxes (including non-trust fund taxes), all penalties and interest.

The IRS assesses whether a person was a "responsible person" for paying payroll taxes on a case-by-case basis. The IRS looks at the totality of the circumstances to determine whether a person had the authority in a business to pay taxes. Some of the factors the court considers include whether a person:

- Was an officer, director, principal shareholder, partner or member of the business
- Had signature authority on checks
- Handled payroll disbursements
- Controlled financial affairs of the company
- Determined which creditors were paid or exercised authority to pay creditors
- Controlled the voting stock of a corporation
- Signed employment tax returns

The employees who are performing ministerial tasks without exercising independent judgment are not generally named as "responsible persons" by the IRS. A non-owner employee who is being supervised, and who does not have the authority make independent decisions on behalf of the employer, will not be asserted the Trust Fund Recovery Penalty (TFRP). Likewise, TFRP is not generally assessed against any volunteer members of any board of trustees or directors of a charitable organization to the extent such members are serving in an honorary capacity, do not participate in the day-to-day or financial operations of the charitable organization, and do not have knowledge of the failure on which such penalty is imposed.

Generally, the IRS will not recommend the assertion of TFRP against an individual if sufficient information is not available to demonstrate that he or she was actively involved in the corporation at the time the tax liability was not being paid. However, this general rule does not apply if the individual intentionally makes information unavailable to impede the investigation. The IRS Revenue Officers conduct field investigations to determine the trust fund recovery penalty liability. The determination of who is the responsible person is a question of fact.

Thus, the Revenue Officers generally determine whether the person in question had the authority to decide to what bills should or should not be paid and when. No TFRP should be assessed where the person does not sign checks, or handle payroll or does not participate in the day-to-day activities of the business. On the other hand, the IRS considers the ability to sign checks and the actual signing of the company's checks as a significant factor in holding an individual responsible for TFRP. Simply put, the IRS is determining who, realistically, ran the business and paid bills on behalf of the employer. This is not necessarily the shareholders and it is not necessarily the board of directors. It may be an employee who had a signature authority on the company's bank account and who signed checks on behalf of the company, for example.

Willful Failure to Pay

According to IRC Section 6672(a), the failure to collect or pay over trust fund taxes must be willful. The term "willful" means an intentional violation of a known legal duty. Within the context of IRC Section 6672, it means a voluntary, conscious, and intentional, as opposed to accidental, decision not to pay over the trust fund taxes to the United States. Internal Revenue Manual (IRM) 5.7.3.3.2.

For non-payment of payroll taxes to be willful for IRS purposes, a responsible person must have either:

- Had actual knowledge that the company had not paid payroll taxes and chose not to pay them
- Recklessly disregarded a risk that the company had not paid payroll taxes

The IRS need not prove a responsible party had actual knowledge that the payroll taxes were unpaid. Those who knew or should have known that a business' payroll taxes were unpaid run the risk of liability; those who were merely negligent in paying taxes do not.

Thus, to establish willfulness, "the government generally must demonstrate that a responsible person was aware, or should have been aware, of the outstanding taxes and either intentionally disregarded the law or was plainly indifferent to its requirements. A responsible person's failure to investigate or correct mismanagement after being notified that withholding taxes have not been paid satisfies the TFRP 'willfulness' element." Internal Revenue Manual (IRM) 5.7.3.3.2. The definition of "willfulness" is very loose. For example, the mere payment of net wages (wages minus trust fund taxes) to employees when funds are not available to pay withholding taxes is considered a willful failure to collect and pay employment taxes, as required by IRC Section 6672.

Assessment Process

The IRS Revenue Officer makes the initial determination of liability for the Trust Fund Recovery Penalty. The Revenue Officer will conduct the initial investigation, using the broad power of the

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