Trust Fund Recovery: Penalties & Pitfalls
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I for one am glad that 2016 finally ended. Coming out of a contentious election with a boat load of vitriol thrown around, I don't know about you, but I was swinging between the need for relief for it all to be over and the fear of who would take over the presidency and if it would go into capable hands. I am so glad tax season started so I can get to the business of preparing returns!
Every year I get a mix of audits my way, but in Tax Year 2016 it seemed as if I saw more than my share of Trust Fund Recovery audits fall into my lap. Some of these small businesses had a tax preparer assisting them and some were on their own.
Trust Funds are those payroll taxes that are withheld from employees' salaries and are to be deposited into the Employer's account with the IRS on a timely basis. To help ensure that taxpayers remit these taxes properly and on time, § 6672(a) imposes a penalty on any person who is responsible for paying and willfully fails to do so. This penalty is known as the Trust Fund Recovery Penalty or TFRP for short.
These funds are considered to be held by the business "in trust" for the government. The responsible person in the business needs to deposit these taxes on a timely basis.
The timeliness of the deposits is determined by the amount of the withholdings. This could be every week/ semi-weekly/ monthly. Businesses are also liable to pay the Federal Unemployment Tax (FUTA) once a year. FUTA is discounted if the employer is signed up for the State Unemployment taxes (SUTA). The SUTA liability is based on the state where the employee is located. So if an employer has employees in various states, they have to keep track of the state unemployment insurance liability in each of those states.
The failure to pay trust fund taxes and/ or the failure to deposit these taxes on time means that either the business or the responsible person is subject to very heavy penalties. Typically, The amount of the penalty is equal to the unpaid balance of the trust fund tax (e.g., Social Security, Medicare, and income taxes).
The penalty is computed based on:
- The unpaid income taxes withheld, plus
- The employee's portion of the withheld FICA taxes.
For collected taxes, the penalty is based on the unpaid amount of collected excise taxes.
Generally, assuming Forms 941, Employer’s Quarterly Federal Tax Return , or comparable returns were timely filed, the IRS has three years to assess the TFRP from the April 15 that succeeded the return’s due date (IRM §220.127.116.11). If the business’s return was filed after the due date, the statute of limitation begins to run from either the April 15 that succeeded the return’s due date or three years from when the return was actually filed, whichever is later. However, false or fraudulent returns or substitute returns prepared by the IRS under Sec. 6020(b)(1) do not start the running of the statute.
Many employers outsource their payroll and related tax duties to third-party payroll service providers. They can help assure filing deadlines and deposit requirements are met and streamline business operations to a large extent. But remember, employers are ultimately responsible for the payment of income tax withheld and both the employer and employee portions of social security and Medicare taxes.
New Deadlines: The PATH Act, enacted in December 2015, includes a new requirement for employers: They have to now file their copies of Form W-2, with the Social Security Administration, by January 31st. The new January 31st filing deadline also applies to certain Forms 1099-MISC reporting non-employee compensation such as payments to independent contractors.
One 30-day extension may be filed by January 31st via Form 8809, Application of Extension to File Information Returns.
I always recommend that a small or medium business hire an Enrolled Agent to oversee their Payroll Taxes payment and filing even if the process has been outsourced to a payroll provider. This ensures 2 sets of eyes on the trust funds. Please call your tax professional immediately if you believe that there may be mistakes on your payroll returns.
As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website, www.mntaxbiz.com.