The Trust Fund Recovery Penalty

The Trust Fund Recovery Penalty

When can the IRS pierce the corporate veil and what you can do if it does

A Tax Article for Corporate and General Practice Attorneys

By Deborah J. Weber

As a corporate or general practice attorney, you no doubt recommend that your client incorporate or form a limited liability company in an effort to limit personal exposure for both acts of employees performed on behalf of the business and for unpaid debts of the business. For the most part, the creation of a separate business and taxpaying entity successfully achieves the desired result.

However, when a corporate employer fails to pay employment tax, the United States government is compelled (for public policy reasons) to credit withheld income and FICA taxes to the employees, despite the fact that the employer has failed to remit said funds. In an attempt to dissuade corporate employers from tapping into the funds that they hold “in trust” for the government, and as a secondary collection source, Congress in its infinite wisdom included §6672 in the Internal Revenue Code, which allows the government to, in essence, “pierce the corporate veil” and hold certain individuals personally liable for the “trust fund taxes”1 that are not fully paid. The liability under IRC §6672 is separate from the liability of the corporation and is joint and several as to the individuals against whom it is asserted.

Who can be held liable?

In order for the Internal Revenue Service to hold a party liable under IRC §6672, it is necessary for the government to show that the party in question:

Held a position of “responsibility” in the company; and

That he or she “willfully” failed to collect and pay over the tax.

Who is Responsible?

There is a plethora of case law addressing the determination of “responsibility.” The IRS and the courts look at several factors, including the following:

  • Did the individual have an entrepreneurial stake in the business or stock ownership?
  • Did the individual hold a high position (i.e., officer, director, etc.)?
  • Was the individual involved in day-to-day operations?
  • Did the individual have the ability to hire and fire?
  • Did the individual have decision-making authority (particularly with regard to financial matters)?
  • Did the individual have control over bank accounts (signature authority)?
  • Was the individual responsible for preparing and/or signing tax returns?
  • Did the individual have the ability to sign for loans?
  • Did the individual have discretion as to which creditors got paid?

This list of factors is not exhaustive nor do all of these factors need to be present in order for the IRS to make a determination that a party is a responsible person.

Who is Willful?

The second element of liability, “willfulness,” has been defined as a voluntary, conscious and intentional act. The IRS takes the position that willfulness exists when money withheld from employees for tax purposes, in lieu of being paid to the government, was knowingly and intentionally used to pay operating expenses or for other purposes. Notably, there is no bad motive requirement.

Although beyond the scope of this article, it should be noted that in egregious situations the Internal Revenue Service can pursue criminal remedies against parties who fail to pay withholding tax. IRC §§7201, 7202 and 7206 provide for felony charges where the failure to collect and pay over is found to be intentional and criminally fraudulent.

What will the IRS do? What can you do?

In the event the Internal Revenue Service determines that a party is both responsible and willful for the unpaid trust fund liabilities of a company, the IRS will mail a 60-day Notice of Determination. This requirement must be met before the IRS can assess the trust fund tax, referred to as the Civil Penalty by the IRS.

File a Protest or Claim for Refund

The potentially responsible party has a right to protest the determination. If a Protest is filed, the government is required to allow a conference with an IRS Appeals Officer, and an assessment cannot be made until a determination is made by an Appeals Officer that the party is liable because both factors are present. The filing of a Protest not only provides the potentially responsible person with his or her only prepayment opportunity to contest the proposed assessment, but it prevents interest from running on the trust fund liability since interest does not accrue until the tax is actually assessed.

In the event of an adverse decision by the IRS Appeals Office, the individual can pay the liability for one employee for one quarter and then file a claim for refund with the Internal Revenue Service. This differs from the standard claim for refund requirement that the entire liability must be paid in full before the taxpayer can file a claim for refund. If the IRS denies the claim, the individual can file a refund suit in the District Court or Court of Claims.

Designate Payments to Trust Funds

It is important to know the rules in relation to filing a Protest, not only to preserve your client’s right to challenge the determination but also to prevent interest from accruing. Additionally, the Protest period provides time for voluntary payments by the corporate taxpayer, if still operating, which can and should be designated to “trust fund taxes only.” This strategy is beneficial to the targeted individual because it can reduce or even eliminate personal liability if the corporation is able to pay the trust fund taxes in full during the Protest period. Full payment or reduction of the trust fund taxes is also advantageous in the event that your client files bankruptcy because trust fund taxes are always considered priority taxes in bankruptcy, meaning that your client will be unable to discharge them in a Chapter 7 or will be required to pay them in full in a Chapter 13.

It should be noted that payments that are not designated properly (for example, payments designated to “tax only”) or payments collected by the IRS through enforced collection will not provide the same benefits to your client. Instead, such payments will be applied “in the best interests of the government,” which typically means that any non-trust fund taxes, penalties and interest will be paid before any trust fund taxes, leaving your client personally liable for the full amount of the trust fund taxes.

Finally, it is often beneficial to enter into an informal installment agreement to pay the corporate tax liability for as long as possible because payments made in this manner are considered voluntary and can therefore be designated to “trust fund taxes only.” However, once a formal installment agreement is entered into, the payments are considered involuntary and the IRS will apply them in the best interests of the government.

What should you do if you have a client who either failed to or just wasn’t able to designate payments to trust funds, then failed to file a timely Protest AND who doesn’t have the money to pay for full blown litigation in Federal District Court? Is all hope lost? The short answer is no. Even after assessment, many options exist that can provide a satisfactory resolution for your client’s problem.

Resolving the Liability Even After Assessment

Even after assessment of a tax, there are several options available to avoid or limit your client’s liability. These include an Offer in Compromise based on Doubt as to Liability, an Offer in Compromise based on Doubt as to Collectibility, and filing bankruptcy.
First, if an Appeals Officer never rendered a determination, your client can file an Offer in Compromise based on Doubt as to Liability and challenge the assessment based on the merits. Second, even if an IRS Appeals Officer found against your client, so long as a Court has never done so, your client can file for bankruptcy and object to the Service’s Proof of Claim. If this occurs, your client will be afforded a hearing on the issue of liability, and he or she may achieve a more desirable result since the Bankruptcy Court is a court of equity. Lastly, whether or not you or your client believes he or she should be held liable for the unpaid trust fund taxes, if you can demonstrate that your client cannot afford to pay the liability based on the formula prescribed by the IRS, your client can submit an Offer in Compromise based on Doubt as to Collectibility.


Trust fund liabilities often involve large amounts of money because they often arise from a company’s inability to pay the withheld taxes of many employees and this often occurs for several quarters. Designation of payments is the first and best way to avoid or limit personal liability. Next, filing a timely Protest to a 60-day Notice of Determination provides your client with an opportunity to avoid liability entirely or to at least limit liability through settlement. Lastly, the submission of an Offer in Compromise or the filing of a bankruptcy can also provide your client with a resolution to the liability. There is no one perfect solution that applies to every client. Rather, each case has its own unique circumstances which warrant its own unique solution.