For U.S. federal tax purposes, the trust fund recovery penalty (TFRP) is imposed under IRC Section 6672 against any person required to collect and pay taxes held in trust and who willfully fails to perform these activities or attempts to evade such tax or payments. The penalty is generally 100% of the unpaid taxes.
The penalty can apply to the following uncollected and unpaid taxes.
- Withheld federal income taxes
- Withheld social security and medicare taxes on employee wages
- Railroad retirement taxes
- Federal excise taxes
Example Penalty for Company with Unpaid Payroll Taxes
Company LLC (the “Company”), a Florida limited liability company (LLC), is owned 100% by John Doe. The Company is a disregarded entity for U.S. federal tax purposes, so John reports all revenue and expenses on Schedule C (Profit or Loss From Business) with his Form 1040.
The Company operates a landscaping business in Florida. John employs two full-time employees and pays each employee $50,000 per year. John runs his payroll and is responsible for calculating the appropriate withholding taxes, filing the quarterly Form 941 (Employer Quarterly Federal Tax Return), the annual Form 940 (Employer Annual FUTA Return), and paying all of the payroll taxes to the IRS.
During the 2023 tax year, John withheld the payroll taxes from his employee’s wages, but he never paid those taxes to the IRS. The Company’s payroll tax liabilities are the following:
- Total Payroll: $100,000
- Federal Income Tax Withheld: $10,000
- Social Security Withheld: $6,200
- Medicare Withheld: $1,450
- Net Pay Issued to Employees: $82,350
Company LLC withheld $17,650 of taxes ($10,000 + $6,200 +$1,450) from its employee’s paychecks. However, John never paid these taxes to the IRS. John kept the funds and used them for other company operating expenses. These are “Trust Fund” taxes because Company LLC was responsible for withholding these taxes on behalf of another party.
The trust fund recovery penalty imposed on Company LLC and John is 100% of the unpaid tax. Company LLC owes the principal sum of $17,650 plus a 100% penalty of $17,650, for a grand total of $35,300.
In addition to the $35,300 trust fund taxes and penalties, remember that Company LLC also owes the employer portion of the Social Security and Medicare taxes. The employer portion is 7.65% of the $100,000 total payroll, for an additional $7,650 of payroll taxes.
When Company LLC calculates its final tax bill, the Company owes $42,950 ($35,300 + $7,650). John will also owe penalties and interest on the $42,950.