Quick overview

Trust Fund Penalties apply when an employer does not forward taxes that were withheld from employees’ paychecks. The IRS treats those withheld amounts as held “in trust” for the government; if they are not paid, the IRS can assess penalties against the business and individuals who are responsible. (See the IRS Trust Fund Recovery Penalty guidance: https://www.irs.gov/businesses/small-businesses-self-employed/trust-fund-recovery-penalty).

Who can be held personally liable?

  • Owners, officers, or partners who have authority over payroll and disbursements.
  • Employees with control over finances when they knew (or should have known) trust funds were not being paid.

Liability is not limited to owners of large companies—sole proprietors and LLC members can be targeted if they control the company’s finances.

How the penalty is calculated and the legal basis

  • Statutory basis: Internal Revenue Code §6672 authorizes the penalty.
  • Amount: generally 100% of the unpaid trust fund portion (federal income tax withheld plus employees’ Social Security and Medicare tax shares) for the period in question.
  • Interest and additional penalties (for late returns or deposits) may also apply. For IRS details and examples, see Publication 15 and TFRP resources (https://www.irs.gov/publications/p15).

Common triggers

  • Using withheld payroll taxes to pay other business expenses during cash shortfalls.
  • Late or missed federal tax deposits (Form 941 and deposit schedule failures).
  • Poor payroll controls or outsourced payroll without adequate oversight.

Practical steps employers should take now

  1. Segregate trust funds: keep withheld taxes in a separate account or clearly earmark them so funds aren’t commingled.
  2. Prioritize deposits: treat payroll tax deposits as the company’s highest priority creditor obligation. If cash is tight, consult a tax professional before reallocating withheld funds.
  3. Use reliable payroll processes: automated payroll services and documented procedures reduce human error. (See our guide on implementing payroll controls: Implementing Payroll Tax Controls to Avoid Trust Fund Penalties).
  4. Reconcile regularly: compare payroll reports, bank statements, and Forms 941 to catch discrepancies early.
  5. Keep clear delegation: document who is responsible for making deposits and filing returns.

For a practical prevention checklist, see: Preventing Payroll Tax Trust Fund Penalties: Best Practices for Employers.

If the IRS assesses a Trust Fund Penalty

  • You will receive an IRS notice showing the assessment and the names of responsible persons.
  • Administrative appeal options exist (e.g., protest to the IRS or appeal to the IRS Office of Appeals). You may also request a Collection Due Process hearing if collection actions begin.
  • Relief is possible if you show reasonable cause or that you were not a responsible person. The IRS explains the process and factors they consider on their TFRP page (https://www.irs.gov/businesses/small-businesses-self-employed/trust-fund-recovery-penalty).

If you disagree with an assessment, document your decision-making, cash flow records, and who controlled disbursements. Many clients I’ve helped successfully reduced or removed assessments by compiling contemporaneous documentation and using the IRS administrative appeal process.

Real-world example

A small retail owner used withheld payroll taxes to cover rent during a seasonal slump. The IRS later assessed the owner personally for the unpaid trust fund portion. After assembling bank records showing who authorized payments and proving lack of willful intent, the owner successfully obtained partial relief through an administrative appeal and negotiated a payment plan for the remainder.

Common misconceptions

  • “It’s just a business debt”: No — trust fund taxes are treated separately and can lead to personal liability.
  • “Only owners are at risk”: Employees with control over payroll or disbursements can also be held liable.

Next steps for employers

  • Review payroll bank accounts and recent Forms 941 and deposit records.
  • If you face an assessment, contact a tax attorney or enrolled agent experienced with TFRP cases immediately.
  • For payroll process repairs, consider third-party payroll services or internal controls training.

Related FinHelp resources

Sources & further reading

Professional disclaimer: This article is educational and does not substitute for personalized tax or legal advice. If your business is under IRS review or you received a TFRP notice, consult a qualified tax attorney, CPA, or enrolled agent immediately.