Quick summary

Trust fund taxes are the payroll taxes employers withhold from employees’ wages — primarily federal income tax and the employee portion of Social Security and Medicare (FICA). Employers act as fiduciaries for those withheld amounts and must deposit them on prescribed schedules. When withheld funds are not remitted, the IRS can assess severe civil and criminal penalties and pursue the Trust Fund Recovery Penalty (TFRP) against responsible persons. (IRS: Trust Fund Taxes: https://www.irs.gov/businesses/small-businesses-self-employed/trust-fund-taxes)

Why this matters now

Unpaid trust fund taxes are treated differently from other business debts because the money withheld from employees was never the employer’s to spend. The IRS can look past the business entity and hold officers, owners, and other responsible employees personally liable. In my practice advising small businesses, I’ve seen owners lose personal assets and face liens because payroll withholding was used to cover operating expenses instead of being deposited.

What counts as trust fund taxes?

  • Federal income tax withheld from wages (employee withholding)
  • Employee share of Social Security tax (6.2% on wages up to the Social Security wage base)
  • Employee share of Medicare tax (1.45% plus any additional Medicare tax when applicable)

Note: The employer’s own FICA share and federal unemployment tax (FUTA) are employment taxes but are not ‘trust fund’ with respect to withheld employee amounts. See the IRS Employer’s Tax Guide (Publication 15) for details. (IRS Pub 15: https://www.irs.gov/publications/p15)

How trust fund tax collection and deposit works

  1. Withhold: Each payroll run, calculate federal income tax and the employee share of Social Security and Medicare.
  2. Hold: Those funds are held in trust — treat them as money belonging to the government.
  3. Deposit: Remit the withheld amounts to the IRS according to your deposit schedule (monthly or semiweekly, determined by your lookback period and total tax liability). Use EFTPS or another IRS-approved deposit method. (IRS: Depositing employment taxes: https://www.irs.gov/businesses/small-businesses-self-employed/depositing-employment-taxes)
  4. Report: File Form 941 (quarterly) or Form 944 (annual for eligible small employers) and issue W-2s at year end. (Form 941: https://www.irs.gov/forms-pubs/about-form-941)

Key operational rule: your deposit schedule depends on your payroll tax liability during the IRS lookback period. If total taxes were $50,000 or more in that period you’re typically a semiweekly depositor; if less, you’re usually a monthly depositor. (IRS deposit rules: https://www.irs.gov/businesses/small-businesses-self-employed/depositing-employment-taxes)

Consequences of not remitting trust fund taxes

  • Trust Fund Recovery Penalty (IRC 6672): The IRS can assess unpaid trust fund tax amounts plus interest and penalties against any ‘responsible person’ who willfully failed to remit the taxes. (IRS TFRP: https://www.irs.gov/businesses/small-businesses-self-employed/trust-fund-recovery-penalty)
  • Failure-to-deposit penalties and interest on the unpaid taxes.
  • Civil actions (liens and levies) and potential criminal prosecution for tax evasion or willful failure to collect/pay taxes.

In practice, penalties and administrative costs often exceed the original unpaid tax. That’s why prioritizing withheld payroll taxes is critical when funds are tight.

Who can be held personally liable?

The IRS looks for two elements: (1) a responsible person — someone with authority over filing and payment decisions (e.g., owners, officers, payroll managers, bookkeepers with control over disbursements), and (2) willfulness — conscious choice to divert withheld funds for other uses. There is no single job title that defines responsibility; the IRS examines control and actual authority.

Practical steps to prevent trust fund tax problems (controls and best practices)

  • Segregate funds: Maintain a dedicated payroll bank account or an account labeled for payroll taxes only. Never use withheld taxes for operating expenses.
  • Automate deposits: Use payroll software connected to EFTPS or a reputable payroll provider to schedule deposits automatically and produce audit trails.
  • Separation of duties: Don’t let one person both run payroll and authorize bank disbursements without oversight.
  • Reconcile regularly: Match payroll reports, bank withdrawals, and deposit confirmations weekly or monthly.
  • Maintain documentation: Keep payroll registers, deposit receipts, EFTPS confirmations, and Form 941 filings for at least four years.
  • Use third-party risk controls: If you use a payroll service, confirm they remit taxes on time and get receipts; don’t assume the vendor is infallible.

See our related guides on payroll setup and employer responsibilities: Payroll Taxes for Employers: Withholding, Deposits, and Forms and How Payroll Taxes Differ for Contractors vs Employees.

What to do if you missed deposits or received an IRS notice

  1. Don’t ignore the notice. Contact a tax professional immediately.
  2. Stop using payroll withholding for other purposes. Reconcile shortfalls and prioritize deposits.
  3. Make deposits as soon as possible through EFTPS to reduce failure-to-deposit penalties and interest. (IRS EFTPS: https://www.eftps.gov/eftps/)
  4. If you’re out of cash, seek emergency financing earmarked only to cover trust fund amounts — lenders sometimes permit loans to cover payroll tax obligations.
  5. If the IRS assesses a Trust Fund Recovery Penalty and you believe it’s incorrect, the penalty can be protested and appealed, but you should preserve records proving lack of responsibility or lack of willfulness.

Remediation options and limits

  • Installment agreements and offers of compromise: The IRS may consider collection alternatives for unpaid employment taxes, but relief for trust fund taxes (especially TFRP) is limited and usually scrutinized closely. An installment agreement can stop some collection actions but may not remove personal liability for the TFRP.
  • Bankruptcy: Trust fund taxes are generally nondischargeable. They survive bankruptcy for the period required by the law.

Examples from practice (realistic, anonymized)

  • A restaurant owner diverted payroll withholding to cover rent and then missed two deposit cycles. The IRS assessed the unpaid taxes and TFRP against the owner and the manager who authorized transfers. Both were required to pay personally. The business eventually failed because the tax liabilities plus penalties consumed cash reserves.
  • A small tech firm automated payroll deposits through EFTPS and maintained a payroll-only checking account. During a revenue shortfall, the owner used a short-term loan to cover payroll taxes and avoided penalties and personal exposure.

Common misconceptions

  • “If my business is behind on taxes, payroll withholding can wait.” False — withheld taxes are a legal trust and should be paid first.
  • “Only owners can be held liable.” False — any responsible person with authority over tax payments can be assessed.
  • “If I file Form 941, I’m protected.” Filing is necessary but does not substitute for depositing withheld amounts. Both filing and depositing are required.

Quick compliance checklist for employers

  • Determine your deposit schedule using the IRS lookback rules.
  • Register and use EFTPS for deposits.
  • Run payroll on time and remit withheld taxes before other nonessential payments.
  • File Form 941 (or Form 944 if eligible) on schedule and retain copies.
  • Reconcile payroll liabilities and deposits every pay period.

When to call a professional

If you receive an IRS notice about unpaid deposits, suspect a shortfall in withheld taxes, or are facing possible TFRP assessment, call a CPA, enrolled agent, or tax attorney experienced in employment tax matters immediately. In my advisory work I prioritize rapid reconciliation and proof of non-willfulness when possible — delaying makes appeals and penalty relief harder.

Authority and further reading

Professional disclaimer

This article is educational and does not replace individualized tax or legal advice. Employment tax issues can create immediate and serious consequences; consult a qualified tax professional or attorney for guidance specific to your situation.