What triggers an Employment Tax Trust Fund Penalty?

The IRS imposes the Trust Fund Recovery Penalty (TFRP) when two elements are present:

  • A tax that is a “trust fund” obligation — meaning federal income tax withheld from employees and the employees’ share of Social Security and Medicare — was not collected and paid over to the IRS. See the IRS TFRP overview for details: https://www.irs.gov/businesses/small-businesses-self-employed/trust-fund-recovery-penalty
  • A person with authority and responsibility over those funds (a “responsible person”) acted willfully in failing to pay them.

Both elements must exist for the IRS to assess the penalty. The penalty equals 100% of the unpaid trust‑fund amount for the period(s) at issue (Internal Revenue Code §6672). See the statutory language at https://www.law.cornell.edu/uscode/text/26/6672.

Who is a “responsible person”?

A responsible person is anyone who had the duty and authority to collect, account for, or pay over withholding taxes. That can include:

  • Owners, officers, and partners
  • Payroll managers and bookkeepers with signatory or payment authority
  • Any person who made the decision to use withheld taxes for other bills

The IRS looks at actual authority and control, not just job title. (IRS guidance: Trust Fund Recovery Penalty overview).

What counts as “willful”?

Willfulness in this context means a conscious, intentional decision to not pay the trust funds, or reckless disregard for the obligation. Common fact patterns the IRS treats as willful include:

  • Using payroll tax withholdings to pay other vendors knowingly
  • Making payroll deposits irregularly or only when cash is available
  • Keeping insufficient records to hide the diversion of funds

A simple cash‑flow problem may not automatically prove willfulness, but repeatedly diverting trust funds usually will. In my practice, the line between temporary cash shortfalls and willfulness becomes critical when the IRS investigates.

Typical triggers (realistic examples)

  • Repeatedly missing payroll tax deposit deadlines and using withheld funds to pay rent, suppliers, or payroll.
  • Authorizing or directing checks that use the business bank account holding withheld taxes for non‑tax liabilities.
  • Management knowledge of unpaid deposits and failure to act (e.g., owner directed to reserve funds but approved other payments instead).

A single missed deposit can trigger inquiries; there is no de minimis monetary threshold for the TFRP.

How the IRS assesses and collects

The IRS can assess the penalty personally against responsible persons for each unpaid period. Collection tools include levies, liens, and offsets against tax refunds. The penalty is assessed only on the trust‑fund portion (withheld income tax and employees’ FICA), not the employer’s matching FICA share. For assessment mechanics see: https://finhelp.io/glossary/how-the-irs-calculates-trust-fund-recovery-penalties/ and the IRS TFRP overview.

Can the penalty be challenged or abated?

Yes. Options include:

  • Demonstrating lack of responsibility or lack of willfulness to IRS Appeals.
  • Filing a claim for refund or abatement where appropriate (Form 843 may apply in some refund scenarios) and/or pursuing an administrative appeal. Consult a tax attorney or CPA—procedures and evidence requirements matter.

See our guide on penalty abatement and appeals for practical steps: https://finhelp.io/glossary/penalty-abatement-requests-building-a-reasonable-cause-case/.

Immediate steps if you’re at risk or receive a TFRP letter

  1. Preserve records: payroll registers, bank statements, payment authorizations, minutes, and communications about cash flow decisions. These are crucial to challenge willfulness.
  2. Stop diverting withheld funds and segregate future trust funds in a separate account.
  3. Contact a tax attorney or CPA experienced in TFRP cases before responding to the IRS. In my experience, early counsel reduces exposure and improves negotiation outcomes.

Prevention: best practices I recommend

  • Automate payroll and deposits with reputable payroll software or a professional payroll provider.
  • Maintain a dedicated bank account for withheld payroll taxes (do not co‑mingle).
  • Run weekly cash‑flow forecasts and build a small reserve for deposits.
  • Document approval workflows so the responsible person and payment authority are clear.

Key takeaways

  • The TFRP attaches when withheld federal income tax and employee FICA are not paid and a responsible person willfully allowed that to happen.
  • The penalty equals 100% of the unpaid trust‑fund tax for the affected periods and creates personal liability.
  • Quick segregation of funds, strong internal controls, and timely professional help are the best defenses.

This article is educational and not individualized tax or legal advice. For case‑specific guidance, consult a qualified tax attorney or CPA. Authoritative sources: IRS Trust Fund Recovery Penalty overview (IRS.gov) and Internal Revenue Code §6672 (26 U.S.C. §6672).