Trust Fund & Payroll Tax Problems

Of all the federal tax problems a business owner can face, an unpaid payroll tax liability is the most personal. The trust-fund portion of every paycheck—the employee's withheld income tax, Social Security, and Medicare—is held by the employer in trust for the United States. When that money is not remitted, §6672 of the Internal Revenue Code permits the IRS to collect the entire trust-fund amount directly from the individuals who controlled the company's finances.

We have defended officers, directors, bookkeepers, and owners against Trust Fund Recovery Penalty (TFRP) assessments for more than four decades. The cases share a common architecture: a business in distress, a payroll obligation that became one of many competing demands, and a revenue officer who eventually arrives looking for someone to hold responsible. The earlier we are involved, the better the outcome.

Who is responsible, and who is willful

The TFRP applies to any person who is both responsible for collecting and paying over the trust-fund taxes and willful in the failure to do so. The case law on each element is voluminous. Responsibility looks at signature authority, decision-making authority over which creditors get paid, and the actual control the individual exercised during the relevant quarters. Willfulness does not require an intent to defraud—it can be established merely by paying other creditors while knowing trust-fund taxes were unpaid.

The IRS conducts its responsibility and willfulness analysis through a Form 4180 interview, often the single most important interaction in a TFRP investigation. We prepare clients meticulously for this interview, review every prior signed document and bank record, and frequently accompany the client to limit the scope of the conversation to what the law actually requires.

State payroll exposure

California adds its own layer. The Employment Development Department administers state payroll taxes—personal income tax withholding, State Disability Insurance, Unemployment Insurance, and Employment Training Tax—and pursues responsible persons under California's own statutes. The CDTFA brings parallel exposure for sales tax, and CUIC §1735 permits personal assessment for unpaid state employment taxes. We coordinate our defense across all three agencies, because settlements with one frequently affect positioning with the others.

Timing matters

The single most common mistake we see is delay. By the time a revenue officer issues Letter 1153 proposing the TFRP, the assessment process is well advanced. The taxpayer has sixty days to file a written protest. Missing that deadline forfeits the right to administrative review and forces the matter into refund litigation, where the taxpayer must first pay a portion of the assessment to obtain jurisdiction. Earlier engagement—at the first revenue officer contact, or even at the point the company first became delinquent— almost always produces a better result.

Resolution paths

Once an assessment is in place, our work shifts to resolution. The options depend on the size of the liability, the financial picture of the responsible person, and the existence of multiple potentially responsible individuals. We routinely negotiate installment agreements, file offers in compromise based on doubt as to collectibility or doubt as to liability, and—where appropriate— coordinate the defense among multiple responsible persons so that contribution rights are preserved.

For business owners whose company is still operating, our work also addresses the going-forward picture: ensuring deposits are current, reviewing the payroll provider, and preventing the cycle from repeating in the next quarter. A TFRP defense that does not solve the underlying operational problem is a defense that will be needed again.

Appeals and litigation

Where the assessment is wrong on the law or unsupported by the record, we file timely protests and take the matter to IRS Appeals. Many TFRP cases settle there, sometimes for a substantial reduction. Where Appeals does not resolve the matter, refund litigation in federal district court remains available and is appropriate for certain fact patterns—particularly cases where willfulness is genuinely contested or where multiple potentially responsible persons should share the burden.

If you are an officer, owner, or financial decision-maker of a company that is behind on payroll taxes—or you have received any contact from a revenue officer about trust-fund exposure—the right time to call is before the next interview, not after.