Wednesday, September 24, 2008

Failure to Collect and Pay Over Tax, or Attempt to Evade or Defeat Tax: Synopsis - trust fund recovery penalty (100% penalty)

An employer is required to withhold federal income taxes, Federal Insurance Contributions Act (FICA) taxes and Railroad Retirement Act (RRA) taxes from employees and to pay over those amounts to the IRS (Code Sec. 3402 and Code Sec. 3501). These taxes withheld from the employee are referred to as trust fund taxes. In addition, the employer is required to pay FICA taxes equivalent to the amount withheld from the employee and to pay Federal Unemployment Tax Act (FUTA) taxes on the employee's wages (Code Sec. 3111 and Code Sec. 3301). Such amounts are generally referred to as the employer's share of employment taxes or non-trust fund taxes.

When the person responsible for collection and payment of such taxes willfully fails to pay over withheld trust fund taxes, a penalty equal to the amount of the delinquent trust fund taxes is assessed (Code Sec. 6672(a)). The trust fund recovery penalty (also known as the 100 percent penalty) only applies to the failure to collect, account for and pay over third-party taxes. It, therefore, does not apply to taxes that are directly paid, such as the employer's share of employment taxes, or to delinquency penalties or interest owed on the delinquent trust fund taxes (Reg. §301.6672-1). The trust fund recovery penalty is generally intended to encourage the prompt payment of the affected taxes and to insure ultimate collection of the taxes from a secondary source.

The penalty may be assessed against the employer, but is most often levied on at least one "responsible person," an individual within the organization who had sufficient authority to pay over the withheld taxes (Code Sec. 6672(a)). See ¶39,780.02 for a discussion of "responsible person."

In typical situations, a struggling business that has fallen behind in its bills pays other creditors before the IRS to assure a continued supply of needed goods and services. Individuals responsible for paying the business's bills may hope that by the time the IRS catches up, the business will have turned around and will have sufficient funds available to satisfy employment taxes and other liabilities. Alternatively, such persons may hope that if the business goes bankrupt, the employment tax debt will be discharged. These individuals often fail to realize that, not only do the business's liabilities gain a measure of priority in bankruptcy (11 U.S.C. §507 and 11 U.S.C. §724(b)), but the persons responsible for paying other business creditors in preference to the IRS may be personally liable for 100 percent of the unpaid trust fund taxes. Furthermore, this personal liability is neither dischargeable in bankruptcy, nor deductible as a business expense or bad debt (see ¶39,780.53). However, a responsible person who pays the penalty has a right of contribution against other responsible persons

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