Many businesses are conducted though entities that are legally “separate” from their owners - i.e. LLC’s, corporations, etc. Generally business debts do not create legal liability for the business owner - absent an explicit personal guaranty by the owner. However for payroll tax debts - obligations can arise for not only the business owner but also individuals who have no ownership stake in the business.
Wait, what??
Let me explain. Stepping back we are discussing tax obligations that arise in connection with business employees - “wage earners”. There are two types of payroll taxes: 1) employee portion, and 2) employer portion. The employee portion consists of income tax withholding as well as withholdings with respect to FICA taxes (Federal Insurance Contributions Act). The FICA tax consists of a combination of payments towards Social Security (6.2%) and towards Medicare (1.45%). The employer is required to make a “matching” payment of the FICA tax - in an amount equal to the employee portion of the tax.
The employee portion of the payroll tax is referred to as a “trust fund” tax. The employer has an obligation to make wage payments to its employees (gross wages). From these gross wages the employer withholds amounts including the employee payroll tax - holding the funds “in trust” for the US government. The failure to remit these funds to the IRS is viewed as a misappropriation of employee funds by the employer.
The employer payroll tax is considered a general company debt - along with interest and penalties. The IRS can enforce collection against the employer upon non-payment but is precluded from enforcing collection on outside parties (i.e. the owner).
The trust fund taxes are also an obligation of the company. The IRS can enforce collection of the taxes directly against the company. Given the serious nature related to non-payment (failure to pay employee held amounts to the government) Congress enacted a specific penalty for unpaid trust fund taxes - equal to 100% of the unpaid trust fund tax. The term “penalty” is somewhat misleading. The amount is not assessed in addition to the taxes owed - it is a collection mechanism - it allows for the IRS to pursue collection against parties other than the wage payor (the business).
This penalty is not limited to the company owner. It applies to any person who is “required to collect, truthfully account for, and pay over any tax imposed” and “who willfully fails to collect such tax, or truthfully account for and pay over such tax”. The IRS takes a rather broad view of responsible persons - typically the owner but also the primary financial manager, and even bookkeepers. Once the penalty is assessed the IRS can pursue the debt with actions allowed for any tax debt collection - including levies and seizures.
But wait doesn’t this mean the IRS can collect more than 100% of the debt? Nope - the concept is similar to the “joint and several” rules that apply to spouses filing joint tax returns. The IRS pursues 100% of the amount due from all parties. Once it has collected all amounts due collections stops. Remember this applies only to trust fund taxes - the employer portion of the tax (along with interest and penalties) is only collectible from the business.
Collection of the tax / penalty is treated as any other collection matter. The IRS will provide various notifications to the debtor, there will be an opportunity for the debtor to be heard by the IRS and/or the courts, and payment alternatives are available - such as installment payments or potentially a debt reduction though the filing of an Offer In Compromise.
The imposing of liability beyond the taxpayer (i.e. the payer of the wages) is the issue that most often requires our assistance. Think for a minute - you are a bookkeeper for a business - you have no ownership interest in the business yet the IRS can, potentially, impose a significant penalty that directly relates to the business. Sure the business and the owner should be held responsible but others as well? Yes that’s what is provided by the law. Congress and the IRS view the failure to pay over trust fund taxes to be a more serious issue than just not paying income taxes - after all these are funds held by the employer on behalf of its employees - in “trust”.
So how does the IRS determine responsibility? They begin with an investigation relating to the company payroll activities - who is involved with the process, who signs checks, etc. The IRS Revenue Officer uses a Form 4180 in order to identify potential responsibility. The form contains a series of yes / no questions - it is not designed to provide context and explanations relating to an individuals activities regarding payroll processing. For this reason we usually recommend that individuals do not participate in an interview with the IRS Revenue Officer. Instead we complete the form with our client and provide commentary with respect to the answers to the questions. This ensures that questions are not merely answered yes or no - which can lead to an incorrect assumption of responsibility.
I will note that the IRS can assert criminal conduct with respect to the non-payment of tax. Say a company owner processes payroll for his employees, withholds payroll taxes, does not make payment, and instead withdraws the money to fund an extravagant lifestyle. In this situation the matter could be elevated from a civil matter to criminal. The government does not take kindly to the mishandling of employee funds. Their enforcement actions reflect this view.
In summary the non-payment of trust fund taxes is a serious issue that cannot be ignored. The liability for these taxes reaches outside of business entities that usually provide legal protection for company debts to owners and employees. The best advice is to think before you speak. Once the IRS makes a determination that you are a responsible party resolving the issue is time consuming and expensive.
In our next blog post we’ll discuss the IRS Appeals Process.
As always feel free to contact us if you need assistance - Send Message / Contact The Author
Link to Outline Slides: Payroll Tax Debt Outline
Link to Video: Payroll Tax Debt Video
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