What is a Trust Fund Recovery Penalty?

A trust fund recovery penalty (TFRP) is a penalty that the Internal Revenue Service (IRS) in the United States can use to collect funds that should have been held in a trust fund and made over to the government. Employers are required to withhold certain amounts from employee paychecks and deposit these amounts in trust for the IRS, making periodic tax payments to the government from the trust. If a business fails to withhold or withholds but does not turn the money over, the IRS can use a trust fund recovery penalty to recover the monies.

The IRS is extremely aggressive about recovering funds that employers are supposed to held in trust. In the eyes on the United States government, these funds belong to the government, and if businesses fail to make their tax payments in a timely manner, the government will put resources to work to collect the money. In addition, failure to submit funds in trust hurts employees, because Social Security and other benefits monies are part of the trust fund. If a business doesn't pay an employee's Social Security, that employee will not have paid into the Social Security fund, and this can have an impact on benefits eligibility.

When the IRS determines that a business is either not collecting funds from paychecks or is not paying the IRS, it will alert the business. The business is usually given time to get current on payments or work out a payment plan. If it does not respond or has become defunct and cannot respond, the IRS can levy a trust fund recovery penalty.

The IRS looks at a business to identify any responsible parties, including accountants, people who process paychecks, and so forth. Any one of these parties can be subjected to a trust fund recovery penalty in the amount of the funds owed. Personal assets can be seized and sold and the responsible person will be pursued if it is not possible to pay the amount in full.

The definition of a “responsible party” can be broad. If the IRS issues a trust fund recovery penalty, people can try to argue that they are not responsible, but a better defense is often that the funds are not collectible. Employees should be aware of the implications of activities like signing checks or otherwise participating in payroll, as these activities can put them at risk of being viewed as responsible parties in the event that the business falls behind on its payroll taxes.