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Tax Penalty For Trust Funds: How The IRS Can Collect Corporate Taxes From You

Tax Penalty For Trust Funds: How The IRS Can Collect Corporate Taxes From You

Taxes on trust funds can create big problems for small businesses. When an employer withholds part of an employee's salary to pay income tax, health insurance, and social security, that money is kept "in custody." It has to go into the treasury every two weeks or every month. Problems usually arise when the business uses these funds for other purposes, such as utilities, rent, or paying other suppliers. Usually, the employer intends to replace "borrowed" trust funds, but cash flow is reduced, and unpaid taxes rise faster than the business can pay. Many business owners failed to realize that when they prioritize other creditors over the federal government, the IRS can tax them personally. The IRS's reach goes beyond what a lot of people believe.

What are trust fund taxes?

When a business pays its employees, it usually does not issue a check for all the employees' wages. The employer is accountable for withholding income tax and the employee's share of social security and health insurance contributions in the employee's salary.

Your employees trust that you will pass this withholding tax on to the proper authorities on their behalf. This is why they are called trust funds taxes.

What occurs when an employer does not pay tax on the trust fund?

When the IRS does not receive a federal tax deposit, an IRS representative will attempt to contact the business owner. In the past, that first contact may not have happened until the employer's unpaid tax obligations started to spiral out of control, but in 2015 the IRS launched the early interactive initiative to address compliance.

The Early Interaction Initiative classifies employers who pay to be defaulting in paying taxes or have a history of late payments. A representative of the IRS reaches out to the employer via a personal call, visit, or letter to provide information and advice. This approach can also take place before the submission of the quarterly tax return.

If the initial approach does not address the situation, a revenue manager will initiate an investigation. This research will focus on those who can make decisions about the finances of the company. This is known as the Trust Fund Collection Investigation. It allows the IRS to receive unpaid taxes from the company's trust fund and the activities of those responsible for non-payment of withholding tax.

What are the sanctions?

The trust fund recovery penalty is equal to the unpaid payroll tax and depends on the unpaid withholding tax and employee participation in FICA withholding tax. The IRS also charges interest on the trust fund recovery penalty so that the responsible individual ends up paying more than the amount of the unpaid payroll tax.

Who can be held responsible?

Suppose the IRS cannot collect the standard payroll taxes from the company. In this case, the penalty for collecting the trust fund may be imposed on any person responsible for collecting or paying withholding tax who does not pay them or who intentionally fails to collect or pay them. Although the responsible party is usually the business owner, this can include anyone who has been authorized to decide how and when to use the business's available cash. This can include shareholders, directors of a corporation, board of directors of a nonprofit organization, and employees authorized to sign bank accounts.

The responsibility lies with the person exercising independent judgment in deciding which creditors to pay. For instance, an employee who pays his bills only on a supervisor's instructions will not be responsible. The employee who decides which invoices will be paid or not will be liable, whether or not, has a stake in the company.

"Willfully" means that the responsible person was or should be aware of the need to pay taxes to the trust and willfully ignored the law or was indifferent to its needs. Using the available funds to pay other creditors instead of the IRS is an indication of willfulness.    

What happens next?

Once the revenue officer has determined the responsible party, he/she will send a letter outlining his/her plan to assess the trust fund recovery penalty. The recipient of the letter has sixty days to appeal. Once the IRS establishes the penalty, it will start attempting to file a complaint against the responsible party or the responsible party's personal properties. This can include filing a federal tax lien or forfeiture of assets. Penalties for the recovery of trust funds are generally exempt from bankruptcy discharge.

In extreme cases, failure to pay trust fund taxes can lead to criminal prosecution. Intentional failure to remit taxes on the trust funds is punishable by a penalty of up to $10,000, 5-years in prison, or both. However, the Internal Revenue Service generally reserves criminal charges for extreme cases where trust fund taxes have been plundered for personal use.

What can you do?

The Internal Revenue Service is aggressive in assessing penalties for trust funds, so if you are not meeting your tax obligations, it is essential to resolve the situation as soon as possible. There are options for resolving the penalties, including an offer to commit, payment agreements, remedies, and even disputes. These options can be complex and expensive; therefore, the best way to avoid collecting penalty funds is to do your best to pay the taxes, even if that means putting the government first over other creditors. When this is not possible, you will need the help of a tax professional such as TAXES MADE EZ, INC. who will help you through the steps necessary to avoid a penalty.



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