“Lord, hou schulde God approve that you robbe Petur and gif is robbere to Poule in ye name of Crist?”
- John Wycliffe, Selected English Works, c. 1380
In medieval England, the Christian Peter and Paul were two peas in a pod. They were both apostles and both martyred in Rome. They even shared the same feast day (June 29). So, the idea behind the phrase “robbing Peter to pay Paul” is that the victim and payee are similar in wisdom and stature (to borrow a phrase). The modern-day equivalent is taking a cash advance from one credit card to make the minimum payment on another one, assuming that they both have a similar interest rate.
Robbing Peter to pay Paul makes little sense, but robbing Rocky Balboa to pay Casper Milquetoast is downright idiotic. Even though he now has a few grey hairs, the Italian Stallion still has a very good left hook. Moreover, he has experience in violent debt collection techniques. Anyone who has ever reached into the company kitty to “borrow” a little 941 or 944 money when things got tight or when a client refused to pay would probably say the same thing about the IRS. The agency has been around for a while, but it still knows how to pack a punch.
Source withholding makes the system work, and this is an idea we’ve touched on before. The first income tax collapsed in part because the difficulties in collecting the tax owed outweighed the benefits of the revenue earned. Then, someone had the bright idea to make employers responsible for collecting the tax, and the 941 was born.
The plan turned out to be pure gold, in more ways than one. In addition to easing collections burdens, source withholding made it easier to increase taxes, since to individual taxpayers, the amount of taxes owed and paid is essentially just a line on a form.
Basics: What are Form 941 taxes?
Form 941 taxes represent the amount of money that an employer must withhold from his or her employees’ wages for remittance to the IRS. This includes social security, Medicare, and income taxes.
In 2015, the social security tax rate was 6.2% for each employee and employer. The social security wage base limit was $ 118,500.
The Medicare tax rate was 1.45% for employees and employers alike. There is no wage base limit for Medicare tax.
For 2015, social security and Medicare taxes were triggered whenever household workers received $ 1,900 or more in cash or an equivalent form of compensation. For election workers, social security and Medicare taxes were triggered in 2015 whenever such persons received $ 1,600 or more in cash or an equivalent form of compensation.
There are only three exceptions to a Form 941 filing requirement:
- Seasonal employers, a term which has a specific meaning in the tax code, who paid no wages in a given quarter,
- Household employers whose workers receive less than $1,900 in cash or cash equivalent, like room and board, in a given year, and
- Farm employers.
If your enterprise does not fall into one of these three categories, and it almost never does, you have an obligation to pay 941 taxes.
What is the trust fund recovery penalty?
To encourage prompt payment of withheld income and employment taxes, including social security taxes, railroad retirement taxes, or collected excise taxes, Congress passed a law that provides for the Trust Fund Recovery Penalty (TFRP). Sec. 6672(a) imposes a penalty on any person who is “responsible” for paying payroll taxes and “willfully” fails to do so.
The term “willfully” has a much broader meaning than many people realize. For example, if a responsible person intended to pay the trust taxes, but was unable to do so due to lack of funds, this is insufficient to support a claim that they were not “willful” under the law.
The trust fund is the portion of the 941 liability that is withheld from the employees’ gross payroll, and due to the IRS in the form of 941 tax deposits. It’s equivalent to the amount of money that the employer withheld from his or her employees’ wages (e.g., social security, Medicare, and income taxes) that was not remitted to the IRS.
It does not include penalty, interest, or the Medicare/Social Security employer-matching portion of the 941 taxes (though, once the Trust Fund Recovery Penalty is personally assessed, it will begin to accrue interest of its own).
The rationale for the TFRP is that the “responsible person” holds these taxes in trust for the government until such time as he or she makes a federal tax deposit in that amount. How can the government circumvent the laws of nature and pierce the corporate veil if the corporate structure shields an individual from personal liability?
While the corporate structure generally shields individuals from personal liability, it does not shield individuals from the TFRP, and a “responsible person” may be personally liable for the TFRP if the business fails to properly remit the required amounts.
The business need not cease operating in order for the TFRP to be assessed.
In what situations does the TFRP arise?
During times when cash is short, business owners may attempt cost-cutting procedures to free up capital, but that may not be enough. To ease an immediate cash flow problem, cash-strapped businesses or other entities may stick their hand into the proverbial “cookie jar” and tap into money withheld from their employees’ wages for Social Security, Medicare, and income taxes. They will use this money to pay creditors instead of paying the IRS.
They mean to “borrow” this money temporarily, but usually fail to pay it back and replenish the coffers. In doing so, the business relegates the IRS to the back of the line of creditors or ignores it altogether, banishing it into the ethers of a deep dark abyss.
The IRS first attempts to collect the entire Form 941 tax liability from the corporation – i.e., the trust fund tax, the non-trust fund tax, penalties and interest. If the corporation cannot pay the tax liability in full or if they drag their heals for too long, then the IRS proposes to assert the Trust Fund Recovery Penalty against the owners, officers, directors, shareholders or other responsible parties.
In the initial stages of an investigation, the revenue officer sets out to determine how much money is owed and who was supposed to pay it. To accomplish both these objectives, the Service typically issues an administrative summons, which is essentially a subpoena that is difficult or impossible to fight and that demands bank account records, cancelled checks, signature cards, and so on.
The Revenue Officer (RO) uses a fine toothcomb to find responsible parties within a business. The RO relies upon a number of “indicators of responsibility” in order to determine who is responsible. If you are an owner (even a 1% share), an officer, or if you have ever signed checks or tax returns for the business, you are an obvious target.
However, just because you may have filled one or more of these roles does not necessarily mean that you were “willful and responsible” under the law. As what might come as a shock, many an innocent employee who lacks significant financial control of a business has become ensnared within the crosshairs of the Trust Fund Recovery Penalty for merely loaning the company money or being the main point-of-contact for the IRS. People falling into this category should be alert to the risk, and protect themselves if they end up with a bulls-eye on their backs.
The procedure is relatively straightforward. First, a RO typically visits the business and asks to meet with the owners, officers, directors, shareholders or other responsible parties. During that meeting, the RO will typically perform a Form 4180 interview with those individuals. This information assists the RO with determining who should be held responsible for the unpaid Trust Fund liability of the corporation.
A person’s answers can be used against him to support the government’s case and it is not at all unusual for RO’s to question potentially responsible persons in a manner as intimidating as a detective interrogating a crime suspect in a small, cramped room under a bright light like that out of a scene from Law & Order. Afterwards, the wayward taxpayer will be “asked” to sign Form 4180, the infamous Report of Interview with Individual Relative to Trust Fund Recovery Penalty or Personal Liability for Excise Taxes.
Once the investigation is complete, if the RO believes that the person is “responsible” and “willful,” he will issue an 1153 letter, in which he proposes to assess the responsible person with the Trust Fund Recovery Penalty. The RO forwards the file to a supervisor, who nearly always approves the issuance of the 1153 letter.
As disparaging as this letter can be, it can also be good news, at least in a way, because it signals that the matter is now out of the auditor’s hands and has passed to a new division. The new person in charge may feel more detached from the matter and be more willing to negotiate favorable terms.
In addition to negotiating with the IRS, you have 60 days from the date on that letter to protest and challenge the proposal. Careful thought should be given to appealing the letter as legal defenses do exist. The last page of Letter 1153 is “Form 2751.” This forms tells you how much the Trust Fund portion is. The amount you owe lies in the bottom-right corner, under the column titled, “Penalty.”
If you receive this letter, and you do not think that you are responsible, do not procrastinate! Otherwise, you could become time-barred from asserting your appeal rights. It is critical that you appeal – or “protest” – this letter as soon as possible. If you miss the deadline, the IRS generally will not grant you another bite at the apple, and you will almost certainly get assessed. And an assessment always presents the doomsday scenario since once an assessment is made, the IRS is free to take enforced collection against your personal assets.
So long as your protest is marked on or before the 60-day deadline, then the IRS must consider your protest, and withhold from assessing the trust fund recovery penalty against you until you have had an opportunity for a hearing. Your protest may be forwarded to IRS Appeals, where a Settlement Officer may hold a hearing to determine whether the RO made a mistake in proposing to assess you.
It is best to draft your protest in such a way as to make it detail-oriented and well-organized, citing legal authority that supports your position. It may also be prudent to submit additional information, such as sworn affidavits from co-workers, documents, records, etc. that directly refute the assertion that you were willful and responsible.
Are there any defenses?
While courts recognize that reasonable cause is a legitimate defense to the assertion of the TFRP, those cases in which the courts have found it are few and far between. To show how high the bar is, even when the owner of a company ordered a responsible person not to pay the taxes, courts have held that the responsible person should have risked being fired rather than pay other creditors (Brownstein, 979 F.2d 952 (3d Cir. 1992)).
The IRS is no less forgiving. Indeed, it takes the intractable position that even a genuine, yet mistaken, belief that the business was required to pay other creditors in preference to trust fund taxes does not make the failure to pay nonwillful (IRM 188.8.131.52.3(7)).
Nonetheless, there are some cases where reasonable cause was found to be an acceptable excuse. Sometimes, the targeted individual was not responsible for withholding taxes pursuant to corporate documents or a partnership agreement; other times, the evidence of willfulness applies to the business entity, but not to the target personally. Furthermore, the IRS is not perfect. It does make clerical errors, especially in the heat of the moment.
How easy is it for the IRS to prove a case?
It is relatively easy for the IRS to prove a case. In addition to past-due tax, the Service must show willfulness; in this context, payments to any other creditors during a quarter is evidence of willful failure to pay.
What if I lose my protest?
If you lose your protest, and you are assessed, all hope is not lost. You can still negotiate for an affordable installment agreement, file for an Offer in Compromise, or request that your account be placed in “Currently Not Collectible” status if the company is in the process of paying back the tax liability or if you are otherwise eligible.
You can also challenge the assessment in Tax Court so long as your petition is timely filed. In some cases, an RO may even refrain from making an assessment so long as the company is current with a payment plan.
How does the IRS apply Trust Fund Recovery Penalty Payments?
The IRS applies payments in its best interest. This means that the IRS first applies a payment made from business assets to the non-trust fund portion of a company’s tax liabilities, and only after that liability is satisfied does the IRS apply payments to the trust fund portion of the taxes.
By following certain procedures, taxpayers generally can designate that the IRS apply the voluntary payments toward the trust fund taxes only. If the individual pays the assessed TFRP but does not agree with the assessment, he or she can then file a Form 843, Claim for Refund and Request for Abatement.
Tattle Tailing on Others
An individual who has been assessed a TFRP should investigate the possibility that other employees are also liable for the TFRP and seek contribution from them. Sec. 6103(e)(9) authorizes the individual to request from the IRS the names of other persons the IRS has found liable – regardless of whether the IRS has attempted to collect the penalty from them – and any amount collected.
However, a person is considered liable under Sec. 6103(e)(9) only when an assessment has been made against him. If there is no assessment against the individual, there is no disclosure.
Remember that although Rocky had some misgivings about breaking thumbs to collect a debt and Peter turned the other cheek, the IRS does not have these scruples. Careful and competent representation can minimize your liability for TFRPs.