When a business runs short of cash, the payroll tax deposit is the easiest bill to skip. The money is already in the account, no one sends an invoice, and the consequences arrive months later. It is also the most dangerous bill to skip, because part of that deposit was never the business’s money. It was withheld from employees’ paychecks and held in trust for the government.
The government treats it that way. The withheld portion can be assessed personally against the owners, officers, and anyone else who decided which bills to pay, and that assessment survives the closing of the business and most bankruptcies.
This article follows a payroll tax case in the order it progresses, for the IRS and for California’s Employment Development Department.
Exposure
Understanding which part of the debt can reach you personally.
Two kinds of payroll tax
Each payroll deposit has two parts. The trust fund portion is the income tax withheld from employees plus the employees’ share of Social Security and Medicare. The employer’s matching share, and the penalties and interest, are the business’s own debt. The trust fund recovery penalty equals 100 percent of the trust fund portion, and that is the part that follows people.
Who is responsible
The penalty is assessed against any person who was responsible for collecting and paying the tax and who willfully failed to do so. Responsibility is about control: signing checks, deciding which creditors to pay, hiring and firing. Willfulness does not require bad intent. Paying any other creditor while knowing the payroll taxes were unpaid is enough. Owners, officers, and sometimes bookkeepers and outside managers are examined.
California
The EDD has its own version. State income tax withholding and disability insurance contributions are trust funds, and the EDD can assess them personally against the responsible officers of a corporation or LLC that fails to pay, with a similar standard.
Stop the Bleeding
Becoming current on new deposits, which every later remedy requires.
Nothing can be negotiated for a business that is still falling behind. The first step, before any conversation with the agency, is to make every deposit due from today forward, on time and in full. For most businesses that means moving payroll to a service that impounds the taxes at each pay run, so that the money leaves the account before it can be spent on anything else.
This step also answers the question the revenue officer will ask first, and it begins to separate the owner who had a bad year from the one who is still using the government’s money to operate.
A voluntary payment can be directed to the trust fund portion of a specific quarter, and we designate every one in writing. Undesignated payments are applied where the government chooses, usually to the business’s own share first, which does nothing to reduce the owner’s personal exposure.
The Business
Resolving the business’s debt, or closing the business in an orderly way.
Payment plans
An operating business that is current on new deposits can obtain a payment plan for the back quarters. Smaller balances qualify for an expedited plan without a full financial review. Larger ones require the business’s financial statements and a revenue officer’s approval, and the officer will want to see that the plan payment is realistic alongside the current deposits.
Offers
A business can submit an offer in compromise for its payroll debt, but the government is reluctant to compromise trust fund taxes while the business operates, and an offer does not resolve the owners’ personal exposure unless it is structured to.
Closing
When the business cannot both operate and stay current, closing it is sometimes the right answer, and doing it in an orderly way limits what follows the owners. Our guide to closing a business covers the sequence. Payroll taxes are near the top of it.
The Investigation
Handling the interview that decides who is assessed.
The interview
Before proposing the penalty, the revenue officer interviews the people who ran the business, using a standard set of questions about who signed checks, who handled payroll, who decided which bills to pay, and when each person knew the taxes were unpaid. The answers are written down and signed. This interview decides the case for most people, and it should never be given without preparation and without counsel present.
Documents
The officer also collects bank signature cards, corporate records, and cancelled checks. We review them first, because they often tell a different story about who actually had control than the titles on the organizational chart.
The proposed penalty
If the officer concludes that a person is responsible, that person receives a letter proposing the penalty and giving 60 days to protest. The protest goes to the Independent Office of Appeals and is the last chance to contest responsibility and willfulness before the penalty is assessed.
Personal Liability
Contesting the assessment, and resolving it when it stands.
The protest
A protest argues that the person was not responsible, did not act willfully, or that the amount is wrong because of payments that should have reduced the trust fund portion. Appeals settles many of these cases, especially where several people were involved and the facts about control are mixed.
After assessment
Once assessed, the penalty is collected from the individual like any other tax debt, and the individual has the same remedies: a payment plan, an offer in compromise, or a hardship hold. The government may collect the full trust fund amount once, from the business or from any of the responsible people, and payments by one reduce the exposure of all.
Bankruptcy
Trust fund taxes are not discharged in a personal bankruptcy. A Chapter 13 case can pay them over time, and a business Chapter 7 does not by itself end the owners’ exposure. This is one reason the business’s payroll debt is addressed before, not after, a decision about bankruptcy.
What It Costs
Representation in a payroll tax case is billed by the hour, because the work depends on how many quarters are involved, whether a revenue officer is assigned, and whether a trust fund investigation is under way. Representation at the interview alone can be a flat fee. We give an estimate at the first meeting after reviewing the notices and the deposit history.
- Every notice from the IRS and the EDD, and any letter proposing a penalty against you personally
- Payroll tax returns and deposit records for the quarters involved
- Bank statements and signature cards for the business accounts
- Corporate records showing officers, owners, and who had authority
- Any interview request or appointment letter from a revenue officer
Gregory Grigoryants is a California attorney (State Bar No. 286804) who has represented individuals, families, and business owners in bankruptcy, debt collection defense, and tax resolution matters for more than 13 years. He practices from offices in Sherman Oaks and Beverly Hills and speaks English and Russian.