Overview

Payroll Tax Trust Fund penalties arise when a business does not timely deposit or remit taxes it withholds from employees—primarily federal income tax withholding and the employee portion of FICA (Social Security and Medicare). The IRS enforces those withholdings as trust funds; failure to turn them over can trigger the Trust Fund Recovery Penalty (TFRP) under IRC 6672, which can assign personal liability to responsible individuals as well as the business. See the IRS Trust Fund Recovery Penalty guidance: https://www.irs.gov/businesses/small-businesses-self-employed/trust-fund-recovery-penalty.

How the penalty works (plain terms)

  • The employer withholds federal income tax and FICA from paychecks and must deposit those amounts according to IRS deposit schedules and rules (monthly or semiweekly for many employers). See Publication 15 for rules on deposits and withholding: https://www.irs.gov/publications/p15.
  • If the employer uses withheld funds for other expenses or fails to deposit them on time, the IRS can assess the TFRP against the business and any individual it finds responsible for the noncompliance. The penalty amount generally equals the unpaid trust-fund taxes.
  • The IRS may also assess penalties and interest for late filing (Form 941/Form 944) and late deposits.

Who is at risk

  • All employers, from one-person LLCs to large corporations, are subject to trust fund rules. The IRS looks beyond job titles; it identifies the person(s) with control over financial decisions and payroll—owners, officers, CFOs, payroll managers, or bookkeepers.

Real-world example (illustrative)

A seasonal landscaping company delayed payroll deposits during a slow month and paid vendors instead. That short-term reallocation led to unpaid trust-fund deposits for a quarter. The IRS later assessed a TFRP against the owner for the unpaid withheld taxes plus interest—creating a personal liability that was far larger than the original cash shortage.

Prevention: practical, prioritized actions

1) Make deposits on time — use EFTPS

2) Build a payroll-first cash management habit

  • Treat withheld taxes as legally-trusted funds. Prioritize payroll tax deposits over discretionary vendor payments. Maintain a short-term payroll reserve equal to one payroll cycle.

3) Use reliable payroll systems and reconciliation

  • Use reputable payroll software or a professional payroll provider. Reconcile payroll registers to ACH/EFTPS payments and to reported amounts on Form 941 each quarter. Regular reconciliation reveals errors early.

4) Implement internal controls and segregation of duties

  • Separate duties for payroll calculation, approval, and payment. Require dual approvals for withdrawals from payroll accounts. Consider a dedicated payroll bank account and clear, auditable records to reduce commingling risk.

5) Maintain accurate books and documentation

  • Keep payroll journals, bank statements, EFTPS receipts, and Form 941 filings organized and retained for at least four years. Good records shorten dispute resolution and support appeals.

6) Train key staff and use checklists

7) Get outside help early

  • If cash flow prevents deposits, consult a tax attorney, CPA, or enrolled agent immediately. Early professional help can identify short-term financing, partial-pay plans, or voluntary disclosure options before an assessment.

What to do if the IRS notifies you

  • Don’t ignore IRS notices. Respond promptly, request records, and if the TFRP is proposed, you can request an administrative appeal or Collection Due Process hearing. Consider contacting the Taxpayer Advocate Service if you face financial hardship.

Common mistakes that lead to penalties

  • Using withheld funds for operating expenses during shortfalls.
  • Failure to reconcile payroll to deposits and returns.
  • Missing EFTPS enrollment or relying on manual checks without confirmation.
  • Centralizing payroll authority without oversight.

Sample short checklist employers can adopt

  • Enroll in EFTPS and confirm credentials.
  • Set calendar reminders for deposit windows and Form 941 due dates.
  • Reconcile payroll register to bank and EFTPS records weekly or monthly.
  • Maintain a payroll reserve equal to one pay period.
  • Implement dual sign-off for payroll disbursements.

Related resources on FinHelp

Frequently asked questions

  • Can the IRS make an owner personally liable? Yes. The IRS can assess the Trust Fund Recovery Penalty against individuals deemed responsible for withholding and remittance decisions.

  • Is there a way to reduce or appeal a TFRP? You can appeal an assessment by following IRS administrative appeal procedures; evidence that you weren’t responsible or that you exercised ordinary business care may prevent assessment. Consult a tax professional.

  • Should I open a separate payroll bank account? A dedicated payroll account improves transparency and makes reconciliation easier, but it is not a guaranteed legal shield—proper bookkeeping and funds prioritization matter most.

Professional disclaimer

This article is educational and does not replace personalized tax or legal advice. For case-specific guidance about potential penalties or appeals, consult a licensed CPA, tax attorney, or enrolled agent.

Authoritative sources

In my experience advising small businesses, the single most effective step is enforcing payroll-first cash discipline and automated deposits. That habit prevents most accidental exposures to trust-fund penalties.