When cash is tight, it can be tempting to pay suppliers or rent first and catch up on payroll taxes later. That is one of the most dangerous decisions a business owner can make. Withheld income tax and the employee share of Social Security and Medicare taxes are trust fund taxes: money held in trust for the government. The IRS explains the consequences on its trust fund recovery penalty page.
What the penalty is
If trust fund taxes are not paid, the IRS can assess the trust fund recovery penalty (TFRP) against any person who was responsible for collecting, accounting for or paying the taxes and who acted willfully in not paying them. The penalty equals the full amount of the unpaid trust fund tax. It is assessed personally, so it can be collected from the individual's own assets, even if the business is a corporation or LLC.
Who can be responsible
Responsibility depends on authority, not title. Owners, officers, partners, bookkeepers with check-signing authority and even outside parties who control which bills are paid can be responsible persons. More than one person can be held responsible for the same taxes.
What "willful" means
Willfulness does not require bad intent. Knowing that taxes were due and choosing to pay other creditors instead is generally enough. Using withheld taxes to keep the business running is precisely the conduct the penalty targets.
Which taxes are covered
The penalty covers trust fund amounts: federal income tax withheld and the employee share of Social Security and Medicare. The employer share and unemployment taxes are not trust fund taxes, though the business still owes them along with penalties and interest.
How to avoid it
- Deposit payroll taxes on time, every time; see payroll tax deposits basics
- Reconcile payroll liabilities monthly, so missed deposits are caught quickly
- Plan cash with payroll taxes as a fixed cost, not an optional one; see cash flow basics
- Act early if you cannot pay: contacting the IRS and filing returns on time preserves options
If it has already happened
File all required returns, even if you cannot pay in full, and seek professional representation. Penalties and interest grow with time.
How we help
Our payroll services reconcile payroll liability accounts every month and alert you to any undeposited balance, which is the earliest warning sign of a trust fund problem.
Warning signs to act on
Missed deposits, using withheld taxes to pay other bills and unopened IRS notices are red flags. Address them immediately.
If you fall behind, contact the IRS early to discuss payment options rather than waiting for enforcement.
Payroll services can reduce risk, but owners remain responsible.
Key terms
Definitions for terms used in this guide, from our small business glossary:
- Assets: Assets are resources a business owns or controls that are expected to provide future economic benefit.
- Liabilities: Liabilities are amounts a business owes to others, such as suppliers, lenders, employees and tax authorities.
- Payroll Liabilities: Payroll liabilities are amounts a business owes from payroll, such as withheld taxes, employer taxes and benefit deductions, until they are paid.
