Trust Fund Recovery Penalty (TFRP): The 100% Personal Liability Trap

Why This Matters for the Exam

The Trust Fund Recovery Penalty is one of the most heavily tested topics on Part 3 because it involves personal liability for business taxes. The IRS can pierce the corporate veil and collect unpaid payroll taxes directly from individuals—even if the business is defunct.

Expect at least 3-5 questions testing your understanding of who qualifies as a "Responsible Person," what constitutes "Willfulness," and how the penalty is calculated.

Legal Foundation: IRC §6672

When an employer withholds income tax and FICA from employee paychecks, those funds are held "in trust" for the government. The employer never owned this money—it was the employees' contribution to the federal tax system. When a business fails to remit these funds, the IRS treats it as misappropriation.

IRC §6672 allows the IRS to assess a penalty equal to 100% of the unpaid trust fund taxes against any "Responsible Person" who "Willfully" fails to pay.

What Is the "Trust Fund" Portion?

Not all payroll taxes are "trust fund" taxes. The distinction is critical:

Key Point: The TFRP only applies to the trust fund portion (employee withholdings). The employer's share of FICA and FUTA are not subject to TFRP—they remain a debt of the business entity only.

The Two-Prong Test for Liability

To impose TFRP, the IRS must prove both prongs:

Prong 1: "Responsible Person"

A "Responsible Person" is anyone with the duty and power to collect, account for, and pay over the trust fund taxes.

Indicators of Responsibility:

• Authority to sign checks on the business bank account.
• Authority to hire and fire employees.
• Authority to determine which creditors get paid.
• Day-to-day control of the business's financial decisions.
• Title of officer, director, or majority shareholder.

Multiple Responsible Persons: More than one person can be responsible. The IRS can (and often does) pursue multiple individuals for the same liability. Each person is jointly and severally liable for the full amount.

Exam Trap: A bookkeeper who can sign checks may be a responsible person, even if they don't have the title of "officer."

Prong 2: "Willfulness"

"Willful" does NOT require intent to defraud. It means a voluntary, conscious, and intentional decision to pay other creditors instead of the IRS when the trust fund taxes were due.

Examples of Willfulness:

• Paying the rent while knowing payroll taxes are past due.
• Paying employees their net wages while not remitting the withheld taxes.
• Paying suppliers to keep the business running while ignoring IRS notices.

Examples That Are NOT Willful:

• Genuinely unaware that taxes were due (but this is hard to prove).
• Delegated all financial duties to another person and had no knowledge.

Critical Concept: If you pay any other creditor while the trust fund taxes are delinquent, you have demonstrated willfulness.

The Form 4180 Interview

When the IRS suspects unpaid payroll taxes, a Revenue Officer will schedule a Form 4180 interview with potential responsible persons.

What They Ask:

• Who had check-signing authority?
• Who made hiring/firing decisions?
• Who decided which bills to pay?
• Were you aware the payroll taxes were unpaid?
• Did you pay other creditors during this period?

Strategic Advice: Clients should consult with a practitioner before the Form 4180 interview. Statements made during this interview are used to establish personal liability.

TFRP Calculation Example

Scenario: ABC Company failed to remit Q2 2024 payroll taxes totaling $50,000. The breakdown is:

• Employee Federal Income Tax Withholding: $20,000 (trust fund)
• Employee FICA: $15,000 (trust fund)
• Employer FICA Match: $15,000 (NOT trust fund)

TFRP Calculation:

• Trust Fund Portion: $20,000 + $15,000 = $35,000
• TFRP Assessed Against Responsible Person: $35,000 (100% of trust fund)

The employer's FICA match ($15,000) remains a debt of the business entity but cannot be assessed against individuals under TFRP.

Key Rules to Remember

Real-World Scenario

Scenario: John is the CFO of XYZ Corp. The company is struggling financially. John knows payroll taxes for Q3 are past due, but he uses available cash to pay the landlord (to avoid eviction) and employees (to prevent walkouts). The IRS assesses $80,000 in TFRP against John personally.

• Is John a "Responsible Person"? Yes—he has check-signing authority and financial control.
• Was he "Willful"? Yes—he consciously chose to pay the landlord and employees instead of the IRS.
• Can John discharge this in bankruptcy? No—TFRP is non-dischargeable.

On the Exam

Expect 3-5 questions on TFRP, typically:

1. Definition Questions: "What is the Trust Fund Recovery Penalty?"
2. Two-Prong Questions: "Which of the following is required to assess TFRP?"
3. Calculation Questions: "Which portion of payroll taxes is subject to TFRP?"
4. Scenario Questions: "John paid the rent instead of payroll taxes. Is this willful?"

The key is to remember: 100% penalty, Responsible + Willful, Trust Fund only, Non-dischargeable.