Here at the Law Office of Stanton D. Goldberg, we advise small business owners and entrepreneurs in the greater Dallas area about their federal and state tax obligations, including those concerning payroll tax withholding. We have posted here about the Trust Fund Recovery Penalty that the IRS may assess against a responsible person when an employer fails to properly withhold, deposit and transfer payroll tax funds to the IRS.
Today we will look at who can be a responsible person for these purposes. It may surprise you how far reaching the definition of a person responsible for payroll tax collection is for an employer. New businesses must be careful to understand these responsibilities to avoid inadvertent personal liability on the part of owners, executives, directors, partners and other high-level personnel.
Payroll tax responsibilities
The IRS requires that every employer follow a comprehensive payroll-withholding system. As every employee knows, the employer withholds federal income tax, Social Security and other taxes from each paycheck for transfer to the federal government on behalf of the employee. Withheld payroll taxes are sometimes referred to as trust fund taxes because the employer is in essence a trustee of the funds until transfer to the IRS.
Sometimes the system does not work as intended. The payroll funds do not get deposited into the correct account. The funds are inadvertently or with the intention of later repaying them used to meet other business expenses. The employer may fail to file required returns or meet deadlines for payment to the IRS.
If the taxes are not paid in the correct amount and on time, the IRS can assess against responsible persons a hefty penalty called the Trust Fund Recovery Penalty or TFRP. The TFRP is equal to the amount of tax that was due, effectively doubling the original liability.
According to the IRS, the agency may assess the penalty against anyone legally responsible for collecting or paying payroll taxes who “willfully” fails to do so, including potentially:
- Anyone with the power to sign checks on behalf of the business or direct how money is paid out
- Payroll Service Providers or PSPs that employers hire to handle payroll
- Professional Employer Organizations or PEOs
- And others
PSPs must be monitored
A responsible person may decide to contract with a PSP to handle all aspects of trust fund taxes. According to Forbes, almost half of small businesses do this.
However, if the PSP fails to handle the transactions correctly, the responsible person can still be liable for the penalty. It behooves every employer who uses a PSP to review regularly that the processes are being carried out as required by law. Basically, a responsible person cannot delegate the payroll withholding responsibility and never look back. Continued oversight is critical to avoid the TFRP.
The issue concerns the willfulness requirement. While to a layperson acting willfully sounds like something active and intentional, for purposes of payroll tax oversight, it can also mean that the person should have been aware of late payroll taxes or “disregarded the law or was plainly indifferent to its requirements,” according to the IRS. Further, to be liable, “no evil intent or bad motive is required.”
The bottom line is that every small business with employees must take care to comply with payroll-withholding laws. It is smart for every executive, owner, manager or anyone else with potential legal responsibility not to put his or her head in the sand after delegating the responsibility to a payroll department or outside service, but to continue to actively supervise and confirm that the process is proceeding according to the law.
The advice of a tax attorney, especially one who is also a CPA, up front can be crucial for successful payroll operations, but legal counsel should also be consulted immediately if the IRS asks questions about payroll or assesses any penalty. In extreme cases, criminal penalties may even be possible, so attorney guidance is a must.