Understanding the penalty
The IRS can assess a penalty, called the "trust fund recovery penalty" against any "responsible person" who willfully fails to collect, account for or remit payroll taxes withheld by the employer. The penalty equals the amount of taxes that the employer should have withheld and remitted to the IRS, and it cannot be discharged in bankruptcy.
The willful failure to collect, account for or remit payroll taxes is also a felony punishable by up to five years in jail and fines of up to $10,000.
In general, any person who can authorize the employer to make payments to creditors will be a responsible person, without regard to that person's actual job responsibilities. Other factors used to identify responsible persons include the allocation of responsibilities under the employer's bylaws or other governing instruments; ownership of the employer's stock or other equity interests; authority to sign checks and tax returns; involvement in day-to-day management; and power to hire and fire employees.
Most executives and closely-held business owners meet the definition of a responsible person because they could force the employer to make a payment to the IRS if they knew it was necessary, or to pay withheld funds to someone else instead. But the trust fund recovery penalty can only be assessed if the responsible person willfully fails to collect, account for or remit payroll taxes.
Willfulness goes beyond a choice not to remit payroll taxes, and can also exist if the responsible person knows about unpaid taxes and fails to act or recklessly disregards a risk that the taxes are not being paid.
The extent of liability
Personal liability can exist even if the executive only becomes a responsible person after the employer initially fails to remit its payroll taxes. In that case, however, the trust fund recovery penalty is limited to the amount of the employer's unencumbered funds on the date the executive becomes a responsible person.
Although payroll tax liabilities can be overwhelming, in most cases they can also be avoided. Verify that reasonable procedures exist to monitor the payroll tax withholding process.
Never entrust one person with sole responsibility for payroll tax filings. Consider using a reputable payroll service to handle payroll tax withholding and payment. And above all else, when cash flow gets tight, never skip a payroll deposit so that other creditors can be paid.
An unpaid vendor may be able to shut down the company, but it cannot put you in jail or seize your house or your 401(k) account. Michael Evans is an attorney with the law firm of Gambrell & Stolz LLP in Atlanta, where his practice focuses on providing solutions to closely-held businesses and their owners in the areas of corporate and partnership taxation, mergers and acquisitions, business succession and estate planning, and employee benefits. Reach Evans at firstname.lastname@example.org.