Trust Fund Recovery Penalty: Personal Liability Under IRC 6672

The Trust Fund Recovery Penalty is the IRS’s tool for collecting unpaid payroll taxes directly from the people who ran a business, not just from the business itself. Under Internal Revenue Code Section 6672, the IRS can assess 100% of the withheld income and FICA taxes that an employer took from workers’ paychecks but never sent to the government against any individual who had authority over the company’s finances and willfully failed to pay them over.¹ The corporate liability shield does not stop it. Once assessed, it becomes your personal debt.

Which Taxes the Penalty Covers

Every pay period, an employer withholds federal income tax and the employee’s share of Social Security and Medicare from each worker’s check.² Those amounts are called trust fund taxes because the employer is holding someone else’s money on the way to the government.

The penalty reaches only that trust fund portion. Employers also owe their own matching share of Social Security and Medicare, but that employer match stays a debt of the business. When payroll taxes go unpaid, the IRS separates what came out of worker paychecks from what the company owed on its own account. Only the withheld portion can become personal liability under Section 6672.³

Who the IRS Can Hold Personally Liable

Two elements have to line up. The person must be a “responsible person” and must have acted willfully.³

Responsibility is a functional test. Your title matters far less than what you actually did. The IRS looks at whether you had the practical authority to decide which creditors got paid. The list of people who can be tagged is broad: corporate officers, directors, shareholders, partners, board members of nonprofits, and anyone else with authority over how the company spent money. Third-party payroll providers and professional employer organizations can also be held responsible, and multiple people can be assessed for the same unpaid taxes.³

Non-Owners and the “Following Orders” Problem

Employees without an ownership stake often assume they’re safe. Courts have rejected that repeatedly. A general manager who signed checks and picked which vendors to pay has been held responsible even with no officer title and no shares. A long-time controller who oversaw finances and prepared payroll has been held responsible even while a lender was directing the company’s liquidation.⁴

Saying you were just following orders from the owner rarely works. The IRS’s position is that officers and higher-level employees may be required to quit rather than comply with instructions to pay other creditors while ignoring federal tax obligations.⁴ There is a narrow exception for an employee whose sole function was paying bills exactly as directed by a superior, with no independent judgment over which creditors to pay.³ The moment that employee exercises any independent financial judgment, the protection disappears.

What Willfulness Means Here

Willfulness does not require an evil motive. The IRS defines it as “intentional, deliberate, voluntary, reckless, knowing, as opposed to accidental.”⁴ If you knew the withheld taxes were due and used the available money for something else, that’s willful.

The usual scenario is a struggling business with tight cash. Someone decides to pay rent, suppliers, or net wages instead of sending the withheld taxes to the IRS. That decision to keep the doors open with money that belonged to the government is the textbook case. Reckless disregard counts too: if you knew there was a history of unpaid taxes and didn’t bother to check the current quarter, that’s enough.

Section 6672 contains no reasonable cause exception.⁵ Some federal circuits have recognized a very limited reasonable cause argument inside the willfulness analysis; others have rejected it entirely. Don’t count on it. The stronger defenses attack responsibility or show that the company’s funds were legally committed elsewhere and genuinely unavailable.

How Much You Owe

The penalty equals 100% of the unpaid trust fund taxes: the withheld federal income tax plus the employee share of Social Security and Medicare. It does not include the employer match, late filing penalties, or interest on the corporate debt.³ If a business withheld $30,000 in income taxes and $15,000 in employee FICA over several quarters and remitted none of it, each responsible person is on the hook for $45,000.

Because the IRS treats this as collecting a tax the business already owed rather than a new one, what you pay is generally not deductible on your personal return. Interest accrues on the assessed penalty if you don’t pay within 21 calendar days of the notice and demand (10 business days if the balance is $100,000 or more), at the IRS underpayment rate until the balance is gone.⁶

Directing Voluntary Payments to the Trust Fund Portion

Here’s a lever many business owners miss. When a company makes a voluntary partial payment on its payroll tax debt, it can designate that the payment apply specifically to the trust fund portion. The designation has to be in writing, accompany the payment, identify the tax period and type, include the employer identification number, and specify the allocation.⁷ Without a designation, the IRS applies the payment in the way most favorable to the government, typically to the non-trust-fund portion first, leaving the personal exposure intact.

The right exists only for voluntary payments. If the IRS collects through a levy or seizure, the government chooses the allocation. Use this before collection actions start.

The Investigation and Letter 1153

The IRS doesn’t just mail a bill. A revenue officer reviews the company’s financial records, bank signature cards, and corporate documents, then interviews potentially responsible individuals using Form 4180 to establish each person’s role, decision-making authority, and knowledge of the unpaid taxes.⁸ Anything you volunteer in that interview about signing checks, choosing which bills to pay, or knowing about the delinquency can and will be used to establish both responsibility and willfulness.

Once a group manager approves the recommendation, the IRS sends Letter 1153 to each person it plans to assess. The letter formally proposes the penalty and gives you 60 days to file a written protest, or 75 days if you are outside the United States.⁹ Miss that window and the IRS proceeds with the assessment, opening the door to liens and levies against your personal assets.

Fighting the Penalty Before Assessment

The 60-day window after Letter 1153 is the best chance to stop the penalty before it becomes an enforceable debt. Your protest goes to the IRS Office of Appeals, which is the only IRS function authorized to make the final administrative determination on a proposed Trust Fund Recovery Penalty.¹⁰ The protest should include a copy of Letter 1153, an explanation of your duties at the business, and the specific reasons you weren’t a responsible person or didn’t act willfully.¹¹

Appeals can resolve cases several ways. A factual settlement may reduce or eliminate the penalty when the evidence shows your authority was narrower than the revenue officer thought. An allocation settlement can split the trust fund liability among multiple responsible persons, as long as the full corporate trust fund debt gets paid. When the facts are genuinely uncertain, Appeals may offer a hazards-of-litigation settlement reflecting the risk the IRS would lose in court.¹⁰ Appeals will not reduce the penalty based on inability to pay or hardship. Only the merits count.

Fighting the Penalty After Assessment

If Appeals upholds the penalty or you missed the pre-assessment window, court is still available. The Trust Fund Recovery Penalty is a “divisible tax,” so you don’t have to pay the whole assessment before suing for a refund. You pay the amount attributable to one employee for one quarter, then file a claim for refund on Form 843.¹² The point is not the refund itself; it is getting a federal judge to rule on the entire assessment.

Form 843 has to be filed for each quarter within two years of the assessment date. If the IRS denies the claim, you then have two years from the disallowance letter to sue in federal district court or the Court of Federal Claims.¹² The Tax Court has no jurisdiction over these cases, so pay-and-sue is the only judicial route.

How Long the IRS Has

Two clocks run. The IRS generally has three years from the date the business’s payroll tax return was filed (or due, if later) to assess the penalty against a responsible person, and Letter 1153 must go out before that assessment deadline expires.¹³ If the business never filed a return for the quarter in question, no limitations period starts, and the IRS can assess indefinitely.

Once assessed, the IRS has ten years to collect, the Collection Statute Expiration Date.¹⁴ After ten years, the debt expires by operation of law, though bankruptcy filings, installment agreements, and offers in compromise can pause or extend the clock.

Bankruptcy Will Not Discharge It

Personal bankruptcy almost certainly will not wipe out a Trust Fund Recovery Penalty. Trust fund taxes are priority debts under the Bankruptcy Code and are specifically excluded from discharge in Chapter 7 and Chapter 13 proceedings.¹⁵ For Chapter 13 cases filed on or after October 17, 2005, the penalty survives discharge regardless of whether it was included in the repayment plan or in a timely proof of claim.¹² The automatic stay may pause IRS collection during the case, but the debt is waiting on the other side.

How It Reaches Joint Assets and Spouses

The penalty is assessed against you individually, but collection reaches property you share with others. A federal tax lien attaches to your interest in a joint bank account. The IRS can also seek a court order to sell jointly owned real estate, with the non-liable co-owner compensated for their share from the proceeds.¹⁶

Spouses who had nothing to do with the business sometimes get caught in it. The IRS has confirmed that the Trust Fund Recovery Penalty is not eligible for innocent spouse relief, so the standard protections for joint-filing spouses do not apply.¹⁷ If the liable spouse’s name is on the house or the bank account, the IRS can pursue those assets case by case. For property held as tenants by the entirety, the Supreme Court has held that a federal tax lien can attach even when only one spouse owes the debt, though the IRS weighs harm to the non-liable spouse before forcing a sale.

1
Office of the Law Revision Counsel. 26 USC 6672 – Failure to Collect and Pay Over Tax, or Attempt to Evade or Defeat Tax
2
Internal Revenue Service. Understanding Employment Taxes
3
Internal Revenue Service. Employment Taxes and the Trust Fund Recovery Penalty (TFRP)
4
Internal Revenue Service. Internal Revenue Manual 5.7.3 – Establishing Responsibility and Willfulness for the Trust Fund Recovery Penalty
5
Taxpayer Advocate Service. National Taxpayer Advocate 2016 Annual Report to Congress – Volume One
6
Office of the Law Revision Counsel. 26 USC 6601 – Interest on Underpayment, Nonpayment, or Extensions of Time for Payment of Tax
7
Internal Revenue Service. General Litigation Bulletin No. 473
8
Internal Revenue Service. Internal Revenue Manual 5.7.4 – Investigation and Recommendation of the TFRP
9
Internal Revenue Service. Internal Revenue Manual 5.7.4 – Investigation and Recommendation of the TFRP – Section: 5.7.4.7 Notification of Proposed Assessment
10
Internal Revenue Service. Internal Revenue Manual 8.25.2 – Working Trust Fund Recovery Penalty Cases in Appeals
11
Internal Revenue Service. Preparing a Request for Appeals
12
Internal Revenue Service. Internal Revenue Manual 8.25.1 – Trust Fund Recovery Penalty (TFRP) Overview and Authority
13
Internal Revenue Service. Internal Revenue Manual 25.6.1 – Statute of Limitations Processes and Procedures
14
Internal Revenue Service. Internal Revenue Manual 5.19.14 – Trust Fund Recovery Penalty (TFRP)
15
Office of the Law Revision Counsel. 11 USC 523 – Exceptions to Discharge
16
Internal Revenue Service. Internal Revenue Manual 5.17.2 – Federal Tax Liens
17
Taxpayer Advocate Service. Do You Feel Like You Are Not Responsible for a Debt Owed by Your Spouse or Ex-Spouse?