Builders and Contractors Exchange
Weekly Bulletin: 1 aug 2008
Your Employees' Tax Withholdings Are not A Piggy Bank
It's tempting, especially during an economic downturn, to view the taxes your business withholds from employees' wages as an extra source of cash. After all, it might take the IRS a while to catch up to you, but if you don't pay your suppliers and subcontractors now you'll be out of business. When it comes to tax withholdings, however, robbing Peter to pay Paul is never a good idea. The short-term fix of using the tax withholdings to pay other bills is likely to lead to long-term headaches, not only for your business, but for you personally.
Federal law requires employers to withhold income tax and Federal Insurance Contribution Act (FICA) tax from their employees' wages. These "trust fund" taxes must be paid over to the IRS on a quarterly basis. Of course, if an employer fails to either withhold the taxes from its employees' wages, or to pay them over to the IRS, the IRS will go after the employer. But many people don't realize that the IRS can also assess a penalty against the employer's individual officers, members, or employees. This penalty-known as the "trust fund recovery penalty," Section 6672 penalty, or "100% penalty"-is equal to the full amount of the taxes owed. Though the IRS can collect the penalty only once, it can assess the penalty against multiple individuals, and proceed against each of them until the full amount is recovered.
Who is subject to the trust fund recovery penalty? Any "responsible person" who "willfully" fails to collect, account for, or pay over the trust fund taxes. To determine who is responsible, the IRS and courts look to how much influence and control a person exercises over the business's financial affairs, particularly the disbursement of funds and decision-making regarding which, when, and in what order debts and taxes are paid. Other relevant factors include the person's position and duties, check-signing authority, ability to hire and fire employees, ownership interest in the business, and management role in the day-to-day affairs of the business. No single factor is determinative. A responsible person is "willful" in failing to collect, account for, or pay over the trust fund taxes if he had some knowledge of the failure or even the risk of failure. If the person knows of payments to other creditors after learning that the trust fund taxes were delinquent, the person has acted willfully. It makes no difference that the person was honest or well-intentioned.
The trust fund recovery penalty can come as quite a shock. The person deemed responsible may have been following instructions not to pay, and while having the authority to override those instructions, may have felt constrained not to. Often, the person planned to pay the trust fund taxes eventually, but needed to pay other bills first to keep the business afloat. The tax law, however, is structured to make the IRS the creditor of choice. Interest on taxes and penalties is steep and compounded daily, and the government has an array of effective tools for collecting what is owed. Unlike many debts, the trust fund recovery penalty cannot be discharged in bankruptcy. If the government gets a judgment that the penalty is owed, the debt will hang on the person's neck like a millstone for twenty years, with interest accumulating, until fully paid. And, in addition to the trust fund recovery penalty, the person could be subject to criminal prosecution, resulting in a fine of up to $10,000 and up to 5 years' imprisonment.
Considering the dire consequences of failing to pay the IRS, you should always pay the tax man first.
Questions?
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This article is meant to bring awareness to this topic and is not intended to be used as legal advice.