Introduction

Trust Fund Recovery Penalties (TFRP) are among the most severe penalties an employer can face: the IRS can hold individuals personally liable for unpaid trust fund taxes (employee federal income tax withheld and the employee portion of FICA), often up to 100% of the unpaid amount. Implementing strong payroll tax controls is the practical way businesses prevent missed deposits, detect problems early, and limit personal exposure. This article lays out the controls, checklists, and steps I use in practice to help clients avoid TFRP and stay compliant with IRS rules (IRS: Trust Fund Recovery Penalty).

Note: This is educational information, not legal or tax advice. For case-specific guidance, consult a qualified tax professional.

Why trust fund taxes matter

Trust fund taxes are money the employer holds in trust for employees and the government — withholding federal income taxes and the employee share of Social Security and Medicare. The IRS treats those withholdings as trust funds; failing to remit them when due can trigger the Trust Fund Recovery Penalty (TFRP), which may be assessed against any “responsible person” who willfully failed to collect, account for, or pay these taxes. For official guidance, see the IRS trust fund recovery penalty page and the IRS payroll tax resources (IRS Payroll Taxes; IRS TFRP).

Who can be held responsible?

The IRS looks beyond job titles. A “responsible person” is anyone with control over financial decisions related to payroll taxes — examples include:

  • Owners, officers, or corporate officers with signing authority.
  • Controllers, CFOs, payroll managers, or bookkeepers who prepare or sign payroll checks.
  • Individuals who hire or fire payroll staff or set payroll policy.

In my practice, I’ve seen small businesses where the owner believed an outside bookkeeper protected them. If that owner retained signing authority or delayed deposits, the IRS still treated them as a responsible person. The IRS provides criteria the examiner uses to determine responsibility (IRS: Trust Fund Recovery Penalty).

Deposit schedules and timing — basics you must follow

Deposit timing depends on your lookback period and tax liability amount. Typical rules include:

  • Monthly depositors: if your total tax reported was below the IRS threshold during the lookback period, deposits are generally due by the 15th of the following month.
  • Semiweekly depositors: if above the threshold, deposits are required more frequently (semiweekly) and often require same-week deposits.
  • Employers must generally deposit employment taxes using EFTPS (Electronic Federal Tax Payment System).

Always confirm current deposit thresholds and rules with IRS guidance — incorrect deposit timing is a common trigger for penalties (IRS: Payroll Taxes; EFTPS).

Core payroll tax controls: foundation and rationale

Well-designed controls reduce human error, tighten accountability, and create evidence the business acted responsibly. Below are the core categories I implement for clients.

  1. Segregation of duties
  • Separate payroll calculation from check signing and bank reconciliation functions. No single person should control all steps from calculation to payment.
  • Use multi-signature approval for large disbursements.
  1. Dedicated payroll bank account or virtual subaccount
  • Maintain a payroll-only account or a clearly labeled subaccount to segregate withheld taxes from operating funds. This helps prevent accidental use of trust funds for operating expenses.
  1. Automated, audited deposit processes
  • Use reputable payroll software or a third-party payroll provider that supports automated tax calculations and EFTPS payments.
  • Enable auto-confirmation emails and daily/weekly reports; configure alerts for missed payments.
  1. Reconciliation and review cadence
  • Reconcile payroll tax liabilities to deposits monthly. Run trial balances between payroll journal entries, payroll register, and bank statements.
  • Independent review: have a senior manager or outside accountant review reconciliations quarterly.
  1. Clear payroll calendar and responsibility matrix
  • Document due dates for deposits, returns (Form 941/940), and payroll tax filings.
  • Maintain a “who does what” list with backup personnel identified.
  1. Access control and change logs
  • Restrict payroll system access to authorized personnel. Log changes to employee pay rates, payroll schedules, and bank routing information.
  1. Written policies and training
  • Maintain a payroll tax policy manual that includes steps for handling missed deposits, emergency signers, and vendor issues.
  • Provide quarterly training for payroll staff and leadership on obligations and red flags.
  1. Cash flow forecasting for tax obligations
  • Include payroll taxes in short-term cash flow models. If cash shortages arise, management must prioritize payroll trust fund taxes (employee withholdings and employee FICA) ahead of nonessential vendor payments.

Practical checklist to implement this week

  • Open a separate payroll bank account or tag a subaccount for tax withholdings.
  • Set up EFTPS and schedule deposits for upcoming payroll cycles.
  • Create a payroll calendar with EFTPS deadlines, Form 941 due dates, and an internal review schedule.
  • Assign primary and backup people with documented sign-off authority.
  • Configure payroll software for automated tax calculations and email confirmations.
  • Run the first monthly reconciliation and have it reviewed by a different person.

Sample payroll control policy (short)

Purpose: Ensure timely and accurate withholding and deposit of payroll trust fund taxes.

Policy highlights:

  • Payroll calculations will be performed by the payroll team and reviewed by Finance.
  • Deposits will be made through EFTPS; confirmation must be saved and attached to the payroll file.
  • A monthly reconciliation will be completed by the 10th of the following month and reviewed by Finance leadership.
  • Any missed deposit triggers an immediate escalation to the CFO and a remediation plan within 48 hours.

Dealing with missed deposits or cash shortfalls

If you miss a deposit: document the reasons, calculate the shortfall immediately, and deposit the funds as soon as possible. File all required returns and keep records. If inability to pay is prolonged, consult a tax attorney or CPA — voluntary disclosure and installment options may mitigate enforcement, but they do not automatically remove TFRP exposure. In many cases, demonstrating prompt remediation, written board minutes, and a corrective plan helps when negotiating with the IRS.

Third‑party payroll providers: benefits and caveats

Using an outside payroll provider can reduce errors and administrative burden. However:

  • Contracts vary: confirm whether the provider agrees to make tax deposits on your behalf and whether they accept liability for mistakes. Many providers will not accept personal liability; the IRS still primarily pursues the employer and responsible persons.
  • Obtain evidence of deposits: insist on regular deposit confirmations and access to payroll reports for internal reconciliation.

Audit trail and documentation

Keep copies of:

  • Deposit confirmations (EFTPS receipts)
  • Filed payroll returns (Form 941, Form 940) and supporting reports
  • Payroll registers and employee withholding authorizations
  • Written policies, training logs, and reconciliations

An organized audit trail is critical if the IRS examines whether the business exercised ordinary business care and prudence.

Practical examples from my practice

  • Case 1: A 12-employee retail firm had commingled funds and missed a monthly deposit. We opened a payroll-only account, moved withheld taxes immediately, implemented a two-step approval for disbursements, and set up weekly cash forecasts. Within one quarter their deposits were timely and the IRS did not assess TFRP after we provided reconciliations and board minutes.

  • Case 2: A startup outsourced payroll but retained check signing for vendor payments with no segregation. The owner was nearly assessed a TFRP because the bank account was drawn down. We restructured vendor payment approvals and required deposit confirmations from the payroll vendor; this evidence helped avoid penalties.

Monitoring and continuous improvement

  • Quarterly internal audits of payroll processes.
  • Annual review of bank signers and payroll system access.
  • Post-mortem whenever a missed deposit occurs to update policies and training.

Helpful IRS and official resources

Related FinHelp articles

Final professional tips

  • Treat withheld taxes as untouchable trust funds — build operational rules that reflect that priority.
  • Document everything: when the IRS evaluates willfulness, documentation of corrective steps and policies matters.
  • If you face potential TFRP exposure, engage a CPA or tax attorney early. Proactive communication and remediation create better outcomes than silence.

Disclaimer

This article is educational and does not substitute for personalized tax, legal, or accounting advice. Rules change and the IRS evaluates cases individually; consult a qualified professional for specific situations.