Overview

Employer Trust Fund Penalties — frequently called the Trust Fund Recovery Penalty (TFRP) — are not ordinary business fines. They convert unpaid payroll taxes that were withheld from employees into potential personal liability for individuals who had authority over payroll and cash decisions. The IRS pursues these penalties under Internal Revenue Code Section 6672 and through its enforcement procedures; the penalty can equal 100% of the unpaid trust fund taxes (federal income tax withheld, employee Social Security and Medicare taxes). (Source: IRS Trust Fund Recovery Penalty page and Publication 15.)

For business leaders and finance officers, understanding how the IRS determines a “responsible person” and what constitutes “willfulness” is the practical key to prevention and defense.

How the IRS determines a responsible person and willfulness

The IRS evaluates two main elements when considering a TFRP assessment:

  • Did the individual have the duty and authority to collect, account for, or pay withheld taxes? (“responsible person”), and
  • Did the person willfully fail to perform that duty?

A “responsible person” is not defined by a single job title. It can include owners, officers (CEO, CFO), controllers, payroll managers, treasurers, or anyone who actually determined which bills to pay and when. The IRS considers evidence of status and authority (signing checks, directing payments, approving payroll, controlling bank accounts) as well as whether the person had the power to pay trust fund taxes but chose not to.

Willfulness in this context is a conscious, intentional disregard or reckless indifference to the requirement to collect, account for, and pay trust fund taxes. Innocent mistakes or simple lack of knowledge are not automatically willful, but repeatedly ignoring the obligation or diverting payroll funds to other uses typically meets the IRS definition of willfulness. (See IRS: Trust Fund Recovery Penalty.)

Typical facts the IRS examines

When investigating, the IRS will look for:

  • Job descriptions, corporate resolutions, and organizational charts showing authority.
  • Who signed payroll checks or approved transfers.
  • Bank records showing funds available but used for other debts.
  • Payroll registers, tax deposits, Form 941 filings, and internal communications.
  • Evidence of efforts (or lack thereof) to pay payroll taxes or to resolve cash shortfalls.

The IRS investigator often prepares an interview and recommendation; if sufficient evidence exists, the IRS will assess the penalty and send a proposed assessment to the person(s) identified.

Real-world examples and pitfalls

  • A controller who paid vendors but not payroll taxes during a cash crunch: if they had authority and used available funds for other obligations, the IRS may find them responsible and willful.
  • An owner who delegates payroll but reviews and approves the bank transfers: delegation does not immunize the owner if they had authority to stop the diversion.
  • Small-business owners who assume corporate structure (LLC or S corp) shields them: it does not for employment tax trust funds — the IRS can pierce the corporate veil for TFRP purposes.

In my practice, I’ve seen mid-size firms where temporary cash-flow decisions produced TFRP assessments for multiple managers because the business lacked clear, enforceable payment priorities for trust fund taxes.

Preventive steps every responsible person should take

  1. Prioritize trust fund taxes in cash management
  • Treat withheld federal income tax and employee FICA (Social Security/Medicare) as trust funds — money held in trust for the government. Never treat those amounts as part of operating cash.
  1. Segregate funds
  • Use a dedicated payroll account and, where practical, a payroll tax sub-account. Don’t commingle payroll tax with operating cash.
  1. Document authority and controls
  • Maintain clear, written policies: who can sign checks, who authorizes transfers, and approval workflows. Keep minutes and written delegations.
  1. Use reputable payroll providers and tax software
  • Outsourcing to a vendor that timely files Form 941 and deposits can reduce risk. Retain service agreements and proof of deposits.
  1. Regular reconciliation and internal audits
  • Reconcile payroll registers to bank deposits and payroll tax returns (Form 941) monthly. Spot discrepancies early.
  1. Establish funding priorities
  • Create a written policy that payroll tax deposits have priority over vendor payments. This policy becomes evidence of intent to comply.
  1. Engage qualified advisors
  • Work with a CPA or tax attorney for payroll setup, monthly reviews, and for guidance if funds are tight.

Related reading: For broader context on employer trust fund taxes and compliance, see our glossary post “Understanding Trust Fund Taxes: What Employers Must Know.” (https://finhelp.io/glossary/understanding-trust-fund-taxes-what-employers-must-know/)

If the IRS notifies you of a TFRP assessment — immediate steps

  1. Don’t ignore the notice
  • Read the IRS letter carefully and note deadlines. The IRS often provides a process for appeal or administrative review.
  1. Gather documentation
  • Bank statements, payroll ledgers, check registers, board minutes, employment agreements, and correspondence about cash decisions. Detailed records are essential to prove lack of authority or lack of willfulness.
  1. Request a Conference or Appeal
  • The IRS allows administrative appeals. You can request an appeals conference or file a written protest if you receive a formal notice of intent to assess. Working with a tax attorney or experienced CPA at this stage increases the chance of a favorable result.
  1. Consider temporary collection relief
  • If assessed and you can’t pay, discuss collection alternatives: installment agreements, offers-in-compromise for civil penalties (in limited situations), or temporarily requesting Collection Due Process. Note: offers-in-compromise related to TFRP assessments are uncommon and fact-specific — consult counsel. (See IRS guidance on collection alternatives.)
  1. Avoid unilateral litigation decisions
  • Do not assume you must pay before suing; however, if you choose to file a refund suit you may need to pay the assessed amount first and then sue for refund in U.S. District Court or Court of Federal Claims. Discuss deadlines and strategy with counsel.

Common defenses and outcomes

  • Not a responsible person: show lack of authority and inability to direct payments.
  • Not willful: demonstrate good-faith attempts to pay or reliance on professional advice that was reasonable under the circumstances.
  • Lack of available funds: if no funds existed to satisfy the trust fund taxes, and there is no evidence of diverting funds, that can undercut a willfulness determination.

Outcome possibilities include full abatement of the assessed penalty, reduction through appeals, or full assessment followed by collection actions (liens, levies, wage garnishments). The IRS has broad collection tools for unpaid liabilities.

Documentation checklist to prepare (if investigated)

  • Payroll tax returns (Form 941), deposit records, and proof of deposit.
  • Bank statements and cancelled checks for the period in question.
  • Board minutes, signed authorizations, job descriptions, and delegation letters.
  • Emails or memos showing instruction or directives about payments.
  • Proof of communications with payroll vendors or banks.

Compiling this evidence quickly improves your ability to contest an assessment or negotiate collection terms.

Practical advice from my practice

  • When cash is tight, document the decision-making process and the steps you took to obtain funds or communicate with lenders. Transparency and contemporaneous documentation make a difference during an IRS review.
  • If you discover missed deposits before the IRS does, correct them immediately and preserve proof. Self-correction can reduce the risk of an enforcement action.
  • Maintain a working relationship with a CPA or tax attorney who can respond quickly when notices arrive — timing is often critical.

Related reading: For operational controls and fiduciary duties that overlap with trust responsibilities, see “Avoiding Common Trustee Mistakes: Duties, Reporting, and Liability.” (https://finhelp.io/glossary/avoiding-common-trustee-mistakes-duties-reporting-and-liability/)

Resources

This information reflects current IRS guidance and common practice as of 2025. Always confirm the latest procedures and timelines directly with the IRS or through a qualified tax professional.

Disclaimer

This article is for educational purposes only and does not constitute legal or tax advice. Individual situations vary—consult a qualified CPA or tax attorney to analyze facts, apply the law to your circumstances, and represent you in administrative or legal proceedings.