What is the Trust Fund Recovery Penalty, and How Does the IRS Calculate It?

The Trust Fund Recovery Penalty (TFRP) is the IRS’s tool for recovering taxes that employers withheld from employees but did not forward to the government. It is not a business-level penalty only — it is a personal liability that can be assessed against one or more individuals who had the authority and responsibility to collect, account for, and pay trust fund taxes.

In my practice working with small-business clients, the most common surprise is learning that the IRS can reach beyond owners and officers to hold payroll managers, bookkeepers, or controllers personally liable when those people had the power to direct payments and knowingly allowed trust funds to be used for other obligations.

Authoritative sources and further reading: see the IRS Trust Fund Recovery Penalty overview (IRS) (https://www.irs.gov/businesses/small-businesses-self-employed/trust-fund-recovery-penalty) and the Employer’s Tax Guide, Publication 15 (IRS) (https://www.irs.gov/publications/p15).

Which taxes make up the “trust fund portion”?

  • Federal income tax withheld from employees’ wages.
  • The employee portion of Social Security and Medicare taxes (FICA) that the employer withholds from wages.

The employer’s own share of Social Security and Medicare, federal unemployment tax (FUTA), and other employer liabilities are not considered trust fund amounts for TFRP purposes.

How the IRS calculates the penalty — step by step

  1. Identify unpaid employment tax periods. The IRS looks at the periods for which the employer failed to deposit or pay required withheld taxes, typically reported on payroll returns such as Form 941 or Form 944.

  2. Determine the trust fund balance. For each period, the IRS totals the withheld federal income tax and the employees’ share of FICA that were not properly paid to the Treasury.

  3. Find responsible persons. Through interviews, questionnaires (the IRS frequently uses a Form 4180-style investigation), bank records, and internal documents, IRS examiners identify individuals with authority and control over finances and payroll decisions.

  4. Test willfulness. The IRS evaluates whether the responsible person’s actions were willful — a conscious, voluntary choice to prefer other creditors over the government or a reckless disregard for tax obligations. Willfulness can also be inferred when trust funds are used to pay other business expenses despite knowing taxes were unpaid.

  5. Assess the TFRP. If responsibility and willfulness are established for a given period, the IRS may assess a penalty equal to the unpaid trust fund amount for that period against each responsible person. Assessments are joint and several — multiple people can be liable for the same tax.

Example: Calculation in practice

  • Quarter 1: Withheld federal income tax + employee FICA = $20,000. Employer paid $5,000. Unpaid trust fund = $15,000.
  • Quarter 2: Withheld = $30,000. Employer paid $0. Unpaid = $30,000.
  • Quarter 3: Withheld = $25,000. Employer paid $25,000. Unpaid = $0.

Total unpaid trust fund across periods = $45,000. If the IRS finds that Jane Doe was a responsible person who willfully allowed those funds to remain unpaid, the TFRP assessed against her can equal $45,000. The IRS can assess the same $45,000 against other responsible individuals as well.

Key legal and practical points

  • The penalty is personal and not limited to business assets. The IRS can pursue personal collections (liens, levies) to satisfy a TFRP once assessed. (IRS: Trust Fund Recovery Penalty)
  • Multiple assessments are possible. The IRS may assess the trust fund penalty against more than one responsible person for the same unpaid period; liability is joint and several.
  • Bankruptcy rarely eliminates TFRP exposure. Trust fund liabilities and TFRP are generally not dischargeable in bankruptcy. (IRS: Trust Fund Recovery Penalty)

Common IRS evidence that supports an assessment

  • Bank statements showing payments to vendors while payroll taxes went unpaid.
  • Corporate minutes or emails demonstrating authority over disbursements.
  • Payroll reports and payroll tax deposit history showing missed deposits for specific tax periods.
  • Testimony or written statements from company personnel.

Situations that often trigger a TFRP investigation

  • Repeated late payroll tax deposits or missed Form 941 filings.
  • Cash shortfalls where payroll taxes appear to have been diverted to operating costs.
  • Complaints during audits or whistleblower information pointing to misapplied funds.

Defenses and mitigation strategies

  • No responsibility: The person had no authority to control payments or pay taxes (e.g., narrow job duties with no discretionary authority).
  • No willfulness: The responsible person lacked the intent or knowledge that taxes were unpaid (for example, they reasonably relied on financial officers or outside payroll providers and had no reason to believe funds were being misused).
  • Reasonable cause: In limited cases, demonstrable circumstances (sudden illness, natural disaster) may justify abatement. Proof and documentation are essential.

Practical steps to respond if you get a TFRP notice

  1. Read every IRS notice carefully and note appeal deadlines. Do not ignore letters; appeals and deadlines are time-sensitive.
  2. Gather documents: payroll records, bank statements, signed checks, board minutes, payroll service contracts and email communications that show who directed payments.
  3. Seek professional representation: an enrolled agent, CPA, or tax attorney experienced with employment tax disputes can guide the factual and legal response.
  4. Consider appeals or administrative review: you can appeal an assessment within the IRS (Office of Appeals) and submit evidence countering responsibility or willfulness. If a levy is issued, Collection Due Process rights may apply.
  5. Negotiate collection options: if the assessment stands, you can request an installment agreement, an Offer in Compromise in limited cases, or request penalty abatement if qualifying circumstances exist.

What I’ve seen work in practice

In many cases I’ve handled, detailed, contemporaneous records — showing who approved payments and why funds were moved — are the most persuasive material when arguing no responsibility or lack of willfulness. Where willfulness is unclear, demonstrating a history of attempted remediation (contacting payroll vendors, board minutes showing cashflow discussions) reduces the chance of a large, uncontested assessment.

Avoiding TFRP risk going forward

  • Prioritize deposits of trust fund taxes even when cash is tight; paying withholding is effectively paying the government first.
  • Use written delegations of authority and maintain a clear chain of who approves payments.
  • Reconcile payroll returns (e.g., Form 941 or Form 944) with bank deposits monthly.

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Authoritative references

Professional disclaimer

This article is educational and does not substitute for personalized tax advice. Cases turn on the facts. If you face a potential TFRP assessment, consult a qualified tax professional (CPA, enrolled agent, or tax attorney) who can analyze your specific situation and representation options.