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Businesses are required to withhold Federal Income Tax, Social Security Tax and Medicare Tax
from their employees’ pay. They must then pay that withheld tax over to the Internal Revenue
IRS is understaffed to the extent that it only reviews transactions long after they have taken
place. Because of the lag, IRS doesn’t contact businesses that are failing to report and pay their withheld tax to the government until long after the failure begins. Unfortunately, businesses
accustomed to greasing “the wheel that squeaks” can fall seriously behind in paying funds to IRS
before they are contacted by the government.
Taxes withheld from employees are referred to as “Trust Fund Taxes”, as employers are required
to treat the withholdings as a fund of the government’s money entrusted to them. Failure to live
up to the trust and pay the withholdings to the government can result in “trust fund penalties”
being imposed against the individuals who allowed the business to shirk its trust fund
The trust fund recovery penalty allows the IRS to assess the unpaid withholding taxes from the
people in the business that were responsible for the failure to pay the trust fund taxes. It charges
the withheld tax personally to the people in the business that controlled who got paid, and
decided to pay others before the government.
The trust fund penalty is equal to the withheld federal income tax, Social Security tax, and
Medicare tax withheld from employees. The penalty differs from other penalties in that it can be
reduced or eliminated if the company or another responsible party pays the taxes due to IRS even
after the penalty is assessed. People assessed with the penalty often wait and hope that another
“responsible person” will pay the tax.
The trust fund penalty applies only to taxes withheld from employees, not to the company’s
matching Social Security and Medicare taxes.
Determining Who Are Responsible Parties
The IRS is responsible for collecting taxes. To make collection easier, IRS will wish wish to find as many people responsible for failing to pay the taxes as possible. IRS’s investigation
concentrates on the apparent authority of the parties involved. The first place to find apparent
authority to pay bills is in the company’s bank account. Who are authorized signers? And who
actually signs the checks? IRS carefully reviews bank records to determine authority. In addition,
IRS conducts interviews with individuals involved in the business to determine who has
authority over the company’s disbursements or over employees who pay bills.
The IRS examiner will review officer titles and job titles of employees. The individuals in the company must carefully explain to the examiner whether the authority usually going with a particular title might have been restricted in practice. The purported “responsible party” and his or her counsel must carefully examine the individual’s actual authority within the actual operation of the company.
Bank Signature Cards and Cancelled Checks
As part of the investigation, the IRS will want to see cancelled checks and bank signature cards.
The signature cards will show who has apparent authority to control payments. The cancelled
checks may show who actually makes the decisions as to who gets paid. If IRS finds a person
authorized on the signature card, or actually signing checks, it will likely treat those individuals
as parties responsible for paying persons other than the government.
Apparent authority is not enough to find a party responsible. Depending on the operation of the
business the authorized signers or the actual check signers may lack the actual authority to
decide who gets paid.
Office managers, bookkeepers, secretaries, payroll administers or clerks are often given authority
to sign checks and do sign them as a convenience to the managers or owners who are deciding
who to pay. IRS must be advised if an employee lacked actual authority even if he could or did
sign checks. The employee’s actual authority will not be apparent from the bank records
Bank signature cards can also cause officers of the company grief. If a person is named Treasurer
or Assistant Treasurer when the company is organized, and signs the bank account authorization,
the actual operation of the company may grow to be quite different. It is the person with
ACTUAL authority to make decisions that should be held to be a “responsible party”, other
employees must make their limited roles clear to IRS.
Writing checks or even signing them can be tasks delegated to people who have no real authority
over the company’s operation. The person directing the payment is likely responsible, but
possibly not the individual following his direction.
The Revenue Officer will want to interview many office employees to determine who are
The Interview will be based on IRS Form 4180–Report of Interview with Individual Relative to
Trust Fund Recovery Penalty or Personal Liability for Excise Taxes.
The Form asks the following questions, and provides for “Yes” or “No” answers. Persons
defending against assessment of the Trust Fund Penalty should prepare answers to each of the
questions in advance, with explanations, and should decline to answer in a “Yes” or “No” format.
o What was your job title?
o Describe your job duties and responsibilities
o Did you determine the financial policy for the business?
o Did you direct or authorize payment of bills or creditors?
o Did you prepare, review, sign, or transmit payroll tax returns?
o Did you have knowledge that withheld taxes were not being paid?
o Did you authorize payroll?
o Did you authorize or make federal tax deposits?
o Did you authorize the assignment of electronic banking passwords?
Each answer should be explained from the point of view of the employee. Was the employee’s
job simply to get the checks signed? Did the employee also prepare the checks? Did the
employee prepare all checks, or only a few? Did the employee prepare checks in the normal
course of business, or only in emergencies? Did the employee have any more than a clerical
function relating to payments? Was each check individually released by a superior?
The Revenue Officer also asks, in relation to his questions, “Could other individuals do these
tasks?” Again, answers must be carefully considered, and should be prepared in advance. The
answer to provide is to state who had decision making authority and control over the payment of bills
and debts. Answers should be truthful, and the employee should try to name individuals who did
have decision making authority in order to emphasize the employee’s own lack of control.
Review Bank Statements
Bank statements and signature cards will be a primary source for IRS’s investigation. Before the
employee is interviewed, he should review the cancelled checks and signature cards. Special
circumstances that caused him to sign checks, or directions that limited his authority when
signing checks, should be explained in writing.
How many checks did the employee sign and under what circumstances? Did another person
actually control which checks were written?
Emphasize any lack of actual authority and lack of control.
If withheld taxes are not paid to IRS, the whole income tax system breaks down. IRS will go to
great lengths to find those responsible for remitting the tax, who did not remit it, in order to collect the tax from any responsible party. Trust fund taxes add up very rapidly, making recovery from any responsible party difficult.
The employee must work to show that, regardless of the bank signature cards, signed checks, or titles and organization charts, the employee lacked actual control and authority for selecting who to pay.