The Internal Revenue Service does not have the resources to audit every single tax return and thus prioritizes its collection efforts. The agency keeps a close eye on the payment of employment taxes withheld from employee paychecks.
When a company does not immediately transfer these funds, also called trust fund payments, to the IRS there are serious consequences. All responsible persons with an ownership interest in or signatory authority for the company can be held liable.
In an effort to encourage prompt payment of these trust fund payments, congress passed the Trust Fund Recovery Penalty. The IRS can assess multiple owners with the 100-percent penalty. Technically any person responsible for collecting or paying withheld income and employment taxes who willfully fails to collect or pay them is liable.
The IRS website provides a long list of possible responsible people, including officers of a corporation, members of a partnership, corporate directors or shareholders. Willfulness requires the individual was aware of outstanding taxes and “intentionally disregarded the law or was plainly indifferent to its requirements.”
One sign of willfulness is when a business uses funds to pay creditors to ease cash flow issues. In one example, the IRS sought an injunction against both an Iowa-based construction firm and its principal for unpaid employment taxes that exceeded $370,000. The IRS claimed in a lawsuit that the firm treated the withheld trust fund payments as working capital in a practice called “pyramiding.”
When attempts to seek voluntary compliance fail, the IRS can obtain an injunction requiring that a company and any principals timely pay employment tax withholdings and file employment tax returns. When litigation threatens, a tax lawyer can often assist in resolving the issue with the IRS.
Source: Forbes, “When Payroll Taxes Pyramid It Means Penalties, Even Jail,” Robert Wood, August 21, 2014.