Employers routinely withhold income and employment taxes from their employees' pay and then deposit the withheld taxes on behalf of their employees. If they fail to do so, a "responsible person" at the company is 100% personally liable for what's called the trust fund recovery penalty (as the taxes are paid into a "trust fund" at the Treasury). More than one person associated with the business can be a responsible person, and the government can assess the penalty from any one of them.
According to tax attorney Barbara Weltman, it's essential for these taxes to be paid before other obligations. Weltman, author of "J.K. Lasser's Small Business Taxes 2024," referred to a recent case in which the CPA of a management consulting company embezzled between $1 and $2 million from the company. The embezzlement was discovered when the CPA had a heart attack.
"The CEO of the company sued to recover the funds, some of which should have been used to pay employment taxes," said Weltman. "Following settlement, the CEO used the funds to pay personal expenses rather than any of the trust fund taxes."
The CEO claimed he was not a responsible person because of his "limited ability to comprehend mathematical concepts." The court said he was a responsible person due to his position, authority and control over the company's affairs. "He also claimed that he didn't act willfully, but willfulness for this purpose doesn't mean evil intent or bad motive," observed Weltman. "It means using funds for anything other than for trust fund taxes."
"The lesson is for the business owner," according to Weltman. "The CPA should know what he is doing. Despite the owner's reliance on an outside payroll service and a bookkeeper, it was nevertheless his responsibility to make sure the taxes were paid."
Another recent case illustrates the distinction, according to Weltman. In this case, the manager of an auto repair shop was authorized to write checks but was not the responsible person. He was only authorized to sign at the direction and with the permission of the owner. "He wasn't the decision maker — the owner of the shop was," said Welt. "He never calculated payroll and only signed checks at the direction of the owner."
According to the IRS, a responsible person is a person or group of people who have the duty to perform and the power to direct the collecting, accounting and paying of trust fund taxes. This may include any of the following:
- An officer or an employee of a corporation;
- A member or employee of a partnership;
- A corporate director or shareholder;
- A member of a board of trustees of a nonprofit organization;
- Another person with authority and control over funds to direct their disbursement;
- Another corporation or third-party payer;
- Payroll service providers or responsible parties within a PSP;
- Professional employer organizations or responsible parties within a PEO; or,
- Responsible parties within the common law employer (client of the PSP or PEO).
The trust fund recovery penalty is not something to take lightly, since it may catch a "responsible person" unawares, according to Weltman. Nevertheless, she added, these penalties have not increased or decreased markedly in frequency.
