Businesses that have employees and pay wages and salaries must withhold federal employee income taxes and the employee’s share of federal employment taxes (FICA) from these wages and salaries. The employer must “match” the employee’s FICA share, and these three components then become the employer’s “federal tax deposit,” which the employer must electronically pay to the IRS periodically. The frequency of when federal tax deposits must be made by an employer varies (weekly, bi-monthly, monthly, etc.) depending on the amount of these federal “payroll” taxes that are due.
The employer must file a return with the IRS every quarter (Form 941), reporting all wages and salaries paid and all federal tax deposits, and pay any resulting difference in tax with this return. Annually, the employer must also file a separate “unemployment tax return” (FUTA – Form 940) and pay FUTA taxes on wages and salaries paid to employees during the year; however, to the extent the employer has also paid local and state taxes on these same wages and salaries (SUTA), the FUTA tax is credited by the amount of SUTA taxes paid during the year.
If any employer does not timely file and/or pay applicable federal employment and unemployment taxes, penalties and interest will be due then. Thus, when an employer has unpaid or “back employment taxes,” the employer owes five separate liabilities: (1) unpaid employee income tax withholdings; (2) unpaid employee FICA; (3) unpaid employer FICA; (4) penalties; and (5) interest. If the employer has also not filed its annual FUTA tax return and paid these taxes, the employer will also owe these FUTA taxes and related penalties and interest as well.
The IRS can, of course, legally collect all unpaid employment and unemployment taxes from the employer, including all unpaid taxes, penalties, and interest. Also, and importantly, the IRS can seek to assess some but not all of the unpaid employment taxes (Form 941) but not any of the unpaid unemployment taxes (Form 940) against the individual “responsible persons” connected with the business. This personal assessment is limited to the unpaid employee income taxes and FICA withholdings. If the employer is a “limited liability business entity,” such as a corporation or limited liability company (LLC), the IRS can generally collect the other “pieces” of the employment tax, including the employer share of FICA, penalties and interest, and also FUTA, but only from the corporation or LLC and not from individuals associated with the business. This limitation presents a number of planning strategies available to business owners when the owner considers that he or she may be personally liable for only some of the taxes, but not all of them.
The personal assessment of business taxes is referred to under many different names, including “Trust Fund Taxes,” “Trust Fund Liability,” “Trust Fund Penalty,” and the “Trust Fund Recovery Penalty.” This personal assessment is not a penalty, however, but a means given to the IRS to collect some of the unpaid employment taxes of a business from its owners and other “responsible persons” of the business. There can be multiple “responsible persons” assessed by the IRS for this liability, but there always will be at least one.
Before the IRS can make this “personal assessment” against an individual for some of the unpaid employment taxes of a business, the IRS generally must conduct a “Trust Fund Investigation” and interview the individual, and others, and review the applicable books and records of the business. The IRS investigator (a “Revenue Officer”) must then issue a proposed assessment to each individual but if the individual disagrees with liability, IRS regulations give the individual the right to administratively “appeal” this decision to the IRS Office of Appeals. The IRS Office of Appeals is an independent branch of the IRS tasked with reviewing disputed assessments, including proposed assessments of this “Trust Fund Tax.”
There are many issues and defenses related to the assessment of the “Trust Fund Tax” by the IRS. This is a complex area. Individuals associated with a business that are contacted by the IRS and where the IRS wishes to speak with the individual about a business and its unpaid employment taxes, must consult with a professional tax advisor or speak with the IRS at their peril.