Quick summary

  • The Trust Fund Recovery Penalty (TFRP) applies to unpaid trust fund taxes (federal income tax withheld and the employee portion of Social Security and Medicare) and can result in personal liability for responsible individuals. (IRS: Trust Fund Recovery Penalty)
  • The TFRP may be 100% of the unpaid trust fund taxes; the IRS can pursue collection from personal assets. (IRS)

How the penalty is assessed

The IRS investigates unpaid payroll (trust fund) taxes to identify the individual(s) who were responsible for collecting and paying those taxes and who willfully failed to do so. If the IRS finds willfulness, it can assess a TFRP equal to the amount of the unpaid trust fund taxes against any responsible person—owners, officers, payroll managers, or other employees with authority over funds. (IRS Trust Fund Recovery Penalty page)

Key points:

  • “Trust fund” refers to taxes withheld from employees that the employer is holding to remit to the government—not a literal separate bank account unless you set one up. Treat withheld wages as funds legally held in trust for the IRS.
  • “Willfulness” does not require an intent to defraud; it can be established when someone knew, or should have known, that payroll taxes weren’t being paid and made no reasonable effort to pay them.

Who can be personally liable

Any person who had the authority and responsibility to collect, account for, and pay withheld taxes can be liable. That can include:

  • Company owners and officers
  • Payroll managers or bookkeepers with control over disbursements
  • Any individual who diverted withheld taxes to other uses despite knowing they were due

For examples and related consequences, see FinHelp’s coverage of how payroll tax liabilities affect owners: How Payroll Tax Liabilities Can Impact Small Business Owners Personally.

Common triggers

  • Using withheld payroll taxes to pay other business expenses when cash is tight
  • Poor bookkeeping that mixes trust funds with operating cash
  • Failing to make timely deposits (monthly or semi-weekly rules depend on payroll size)
  • Repeated late payments or ignored IRS notices

Practical steps to prevent a TFRP

  1. Segregate withheld taxes: Place withheld payroll taxes in a separate bank account, or at minimum clearly mark and reserve the amounts before spending. This is one of the clearest signals that funds were treated as trust funds.
  2. Maintain a clear payroll calendar: Track deposit and filing deadlines and reconcile payroll accounts weekly. See FinHelp’s guide: Creating a Compliance Calendar for Small Business Taxes.
  3. Use internal controls: Require dual sign-off for large disbursements, limit access to payroll accounts, and review payroll reconciliations regularly.
  4. Get professional help early: A CPA or payroll provider can catch problems before they escalate.

If you receive an IRS notice or proposed TFRP

  • Act immediately. Collect payroll records, bank statements, and copies of deposits and filings.
  • Contact a tax professional and consider legal counsel experienced with payroll tax collection and penalties.
  • You can request an appeal of the assessment and present evidence that you were not a responsible person or that you acted with reasonable cause.

Options for relief or collection mitigation

  • Administrative appeal: You can dispute the IRS’s finding that you were a responsible person or that you acted willfully.
  • Reasonable cause relief: In limited situations, the IRS may abate penalties for reasonable cause if the taxpayer can show facts that justify relief.
  • Collection options: If assessed, the IRS may pursue levies, liens, and garnishments; you can explore payment plans or, in rare cases, offers in compromise. Consult a practitioner—options depend on the facts and total tax liability. (See IRS penalties and collection guidance.)

Real-world practice note

In my practice working with small employers, the most common cause of TFRP assessments is a pattern of using withholding to cover operating shortfalls without a documented plan to catch up. Simple, consistent measures—segregating funds, establishing a small short-term loan rather than raiding payroll withholdings, and keeping a running reconciliation—prevent the vast majority of problems.

Recordkeeping and documentation to keep

  • Payroll registers and copies of Form 941 filings
  • Bank statements showing deposits and disbursements
  • Payroll tax deposit records and any payroll service provider agreements
  • Board minutes or emails showing who had authority over payroll disbursements

Authoritative sources and next steps

This article is educational and does not replace individualized tax or legal advice. If you face a proposed TFRP or have concerns about payroll withholding, consult a qualified tax professional or tax attorney promptly.