Trust Fund Recovery Penalty: What It Is (and How To Fight It)

What is the TFRP?

The Trust Fund Recovery Penalty (TFRP) allows the IRS to hold certain individuals personally liable for the unpaid employment taxes of a business. Under Section 6672 of the Internal Revenue Code, any person who is required to collect and pay over any tax and fails to do so may be liable for a penalty equal to the amount of tax that should have been paid to the IRS. In order to be liable for the TFRP, the person (1) must be responsible for collecting or paying the tax and (2) must have acted willfully in failing to pay the tax. I.R.C. § 6672(a).

Appealing the TFRP

Generally, before assessment of the TFRP, the IRS will attempt to collect the unpaid employment taxes from the business. However, if the collection is unsuccessful, the IRS may begin developing a case file related to the assessment of the TFRP. See I.R.M. 11.3.40.5.2. The investigation is typically conducted by a revenue officer who may interview one or more individuals to determine who is responsible and whether the responsible individuals acted willfully.

After conducting the investigation, the revenue office may recommend that the TFRP is assessed. At that time, Letter 1153 will be mailed to the responsible individual(s). If the responsible individual agrees with the determination, they may respond to the letter affirming that they agree to the proposed assessment of the TFRP. Ignoring the letter will also result in an assessment of the TFRP. If the individual disagrees with the proposed TFRP assessment, they can attempt to informally resolve the case with the assigned revenue officer. However, if they are unable to resolve the case informally, they will need to submit an appeal within 60 days of the date of the letter.

TFRP Defenses

What kind of arguments should an individual submit with their appeal? As mentioned above, there are two prongs to TFRP liability: (1) responsibility and (2) willfulness. I.R.C. § 6672(a). Thus, successful appeals will address these two elements. An individual may try to argue against the responsibility element, the willfulness element, or both.

The determination of responsibility hinges on whether the person had “effective power to pay taxes.” Raba v. United States, 977 F.2d 941, 941 (5th Cir. 1991). A number of factors have been used by the courts in determining responsibility, including whether the individual: (1) is an officer of the business; (2) holds stock or an ownership interest in the business; (3) manages the day-to-day operations of the business; (4) has the ability to hire and fire employees; (5) makes decisions as to the disbursement of funds to creditors; and (6) has check-signing authority. Raba, 977 F.2d at 943; Barnett v. IRS, 988 F.2d 1449, 1455 (5th Cir. 1993).

Although the courts tend to cast a “broad net” in terms of determining who is responsible under Section 6672, responsibility alone is insufficient to apply the TFRP; there must also be willfulness in failing to pay the taxes. Bowlen v. United States, 956 F.2d 723, 728 (7th Cir.1992) (“Section 6672 casts a broad net of liability . . . .”); McCarty v. United States, 437 F2d 961, 967 (Ct. Cl. 1971) (“Responsibility without willfulness is not enough.”).

Willfulness requires some type of voluntary action or inaction. Barnett, 988 F.2d at 1457. It is usually evidenced by the fact that the responsible person paid other creditors before paying withholding taxes to the government. Johnson v. United States, 734 F.3d 352, 364-365 (4th Cir. 2013). Further, mere negligence is not sufficient to show that the responsible person acted willfully. Calderone v. United States, 799 F.2d 254, 260 (6th Cir. 1986). The responsible person must have taken some deliberate action to cause the withheld taxes to not be paid to the government. Id. Alternatively, willfulness may be demonstrated if the responsible person acted with reckless disregard of a known risk that the taxes were not being paid. Mazo v. United States, 591 F.2d 1151, 1156 (5th Cir. 1979).

A good TFRP appeal will touch on at least one of the elements of Section 6672. It is important to include both legal arguments and relevant facts to support one’s argument in the appeal. Additionally, the taxpayer should include exhibits to support their factual claims. If the appeal does not present any new evidence to consider that would change the TFRP proposal, the revenue officer will forward the case to the Independent Office of Appeals (“Appeals”).

Collection

If the taxpayer is unable to resolve the case with Appeals, the TFRP will be assessed against the individual. At that point, the individual may wish to pay the penalty or seek a collection alternative, such as an installment agreement or offer in compromise. If the individual does not have enough assets to pay the penalty, they may be a good candidate for an offer in compromise on the grounds of collectability. However, even if the individual does have enough assets to pay the balance in full, they may be able to get an offer in compromise on equitable grounds.

Seeking an offer in compromise on equitable grounds may give the taxpayer another bite at the apple. Section 7122 grants the Internal Revenue Service the authority to settle tax liabilities through an offer in compromise. Under Treasury Regulation § 301.7122-1, “the IRS may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability.” The Regulations go on to state that a compromise on the grounds of effective tax administration is justified when “collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner.”

If the individual has a compelling argument as to why paying the penalty would be unfair to the taxpayer, the taxpayer may want to consider submitting an offer in compromise on equitable grounds. The taxpayer should include an “Explanation of Circumstances” with their offer explaining why collection of the penalty would be against public policy. Similar to the TFRP appeal, a strong Explanation of Circumstances includes legal authority, factual claims, and supporting evidence.

Conclusion

The best way to prevent assessment of the TFRP is by paying employment taxes on time. Business owners and corporate officers should remain diligent in ensuring that employment taxes are being paid—even if the business has hired someone else to manage the tax filings of the business. However, mistakes happen. Individuals that find themselves in a TFRP investigation should seek guidance from a tax attorney on navigating the revenue officer interview, Appeals process, and collection.