Overview of the IRS Trust Fund Recovery Penalty for Commercial Lenders Published June 2, 2014
It’s common knowledge that the IRS is the most powerful collection agency in the land. Their enforcement reach is vast and can choke a business out of existence by levying account receivables, merchant processing accounts, bank accounts, and basically any and all assets of the business.
As such, commercial lenders assess credit risk accordingly and do their due diligence through various risk management strategies to minimize exposure.
One tool in the IRS’s collection arsenal that gets commonly overlooked is their ability to pierce the corporate veil and go after the responsible individuals personally for a portion of the business’s unpaid tax liabilities. This is formally known as the Trust Fund Recovery Penalty (TFRP) that can be assessed to individuals.
As commercial lenders, this may or may not be of issue with respect to your collateral exposure, but having some general understanding of the capabilities of the TFRP could be of help to you should one of your borrowers be faced with such a situation. If there are some personal guarantees or cross-collateralization at play, or any other tangle up between the personal and business assets, there could be some exposure that would require deeper investigation should a borrower be hit with the TFRP.
Let’s start with the basics.
What are Trust Fund taxes?
Employers are required to withhold amounts from their employees’ salaries to cover individual Federal income, Social Security, and Medicare taxes. The employee share of taxes, which the business has a fiduciary responsibility to hold “in trust” until paid to the IRS, is referred to as a trust fund tax. Employers should also make matching contributions for their own amounts for Social Security and Medicare taxes and deposit both amounts with the IRS through the filing of employment tax returns.
Form 941, Employer’s Quarterly Federal Tax Return, is used to file and establish the tax liability for the majority of trust fund taxes. Employers with tax liabilities of $2,500 or more per quarter are required to make Federal tax deposits. Employees who have taxes withheld from their wages expect the funds to be properly remitted to the IRS.
What is the Trust Fund Recovery Penalty?
A Collection tool provided by Internal Revenue Code Section 6672 against any person required to collect, account for, and pay over taxes held in trust who willfully fails to perform any of these activities, or willfully attempts to evade or defeat any such tax or its payment. Simply put, when a business does not remit trust fund taxes withheld from its employees, the IRS can collect the unpaid taxes from the individuals responsible by assessing the TFRP when appropriate.
Determination of identifying who are the “willful and responsible” individuals and when it’s appropriate to assess the TFRP the IRS has some rather broad guidelines. To show willfulness, the Internal Revenue Manual (IRM) requires that the Government generally must demonstrate that an individual with responsibility was aware, or should have been aware, of the outstanding taxes and intentionally did not make the payments. A responsible person’s failure to investigate or correct mismanagement after being notified that withholding taxes have not been paid satisfies the TFRP “willfulness” element.
Responsibility is a matter of status, duty, and authority. A determination of responsibility is dependent on the facts and circumstances of each case. A responsible person has: (1) the duty to perform; (2) the power to direct the act of collecting trust fund taxes; (3) the accountability for, and authority to pay, trust fund taxes; and (4) the authority to determine which creditors will or will not be paid. A responsible person may be one or more of, but not limited to, the following:
-Officer, director, shareholder, or employee of a corporation.
-Limited/nominal partner or employee of a partnership.
-Employee of a sole proprietorship.
-Limited liability company member, manager, or employee.
As we all know in the business world of lending and due diligence, employers sometimes fail to make their required tax deposits. And based on the most recent available numbers from the IRS this outstanding amount is in the neighborhood of $39 billion (including collectable and non-collectable liabilities).
This a large and serious problem for the IRS that they’re actively working on and aggressively pursuing offenders. And for the commercial lender, the general understanding that businesses and their individuals responsible for Trust Fund taxes could present a risk to either their collateral or loan performance is, at the very least, important in order to mitigate risk.
Therefore, knowing if a business is missing tax deposits or tax returns, is deep in the throes of the IRS collection process, and/or if a TFRP has been assessed to the individuals you’re dealing with, is all valuable information to you. Sometimes it’s not just a box to check off whether the business has a tax lien or not. Rather, using all the resources available to you through due diligence is a way to better know, understand, and maybe even guide your borrowers to success to improve the quality of your portfolio and relations with your clients.
If you have any questions about how the TFRP or the IRS collection processes works, please contact us and we’re available to walk you through it all.