Payroll Tax Compliance: A Company Priority with a Personal Risk
Virtually every business leader knows it is important to remit payroll taxes promptly. Failing to make payroll tax deposits as required could expose a company to serious financial and regulatory risk.
What is less commonly known, however, is that the risk doesn’t stop with the company. The IRS can also hold responsible individuals personally liable if their company fails to meet federal payroll tax deposit requirements. Business owners, executives, directors and even non-owner employees with financial responsibilities could find themselves personally liable for the full amount of unpaid payroll taxes plus interest.
A Matter of Trust
When a company withholds income tax and Social Security and Medicare taxes from its employees’ pay, the money being withheld no longer belongs to the company—it belongs to the US Treasury. The employer is merely holding the money in trust temporarily and is required to deposit those funds with the IRS on a timely basis (Depositing and reporting employment taxes). From the Treasury Department’s perspective, failing to make timely deposits amounts to misuse of government funds.
To encourage prompt payment of withheld income and employment taxes, Section 6672 of the Internal Revenue Code (IRC) provides for a Trust Fund Recovery Penalty (TFRP). This is a civil penalty the IRS can assess against any individual who is responsible for remitting withheld payroll taxes and willfully fails to do so.
The penalty makes such individuals personally liable for up to 100% of the unpaid trust fund taxes, plus interest. This liability is not confined to one person, as the IRS may pursue multiple individuals who could be found jointly and severally liable up to the full amount of unpaid payroll trust fund taxes.
Critical Terms and Concepts
Under IRC Section 6672, two conditions must be met before the IRS can impose the TFRP on an individual. First, the person being penalized must be a “responsible person,” and second, the failure to remit the trust fund money must have been “willful.” Both of these requirements are critical.
The IRS defines a “responsible person” as any “person or group of people who has the duty to perform and the power to direct the collecting, accounting and paying of trust fund taxes.” This person may be an officer or employee of a corporation, a member or employee of a partnership, a corporate director or shareholder or even a member of a nonprofit organization’s board of trustees—in short, any person who either directs the disbursement of funds or has the authority to do so.
The second critical term is “willful.” For willfulness to exist, the responsible person either must have been aware or should have been aware of the outstanding taxes and then either intentionally disregarded the law or was plainly indifferent to its requirements. No evil intent or bad motive is required. To the IRS, simply using available funds to pay other creditors while employment tax deposits are overdue is an indication of willfulness. Giving employees net payroll checks with no intent or ability to remit the required withholdings also meets the willful requirement.
Recognizing and Mitigating Risk
Payroll tax problems are more likely to arise when companies are under financial stress. Start-ups and early-stage businesses where cash flow is tight can be especially vulnerable. Under pressure from vendors, landlords, lenders or other creditors, financial managers are sometimes tempted to delay making tax deposits—“only temporarily,” of course—in order to cover other bills.
This is always a bad idea. Among all the creditors a company may face, the IRS must always come first. Choosing to pay others before making payroll tax deposits not only exposes the company to regulatory risk, it also exposes individuals to personal liability.
Outside payroll service providers that handle withholding tax deposits are also subject to the TFRP. Note, however, that using a third-party payroll service does not relieve an employer of its payroll tax liability, and it does not shield responsible persons within the employing company from the TFRP. If the third-party payroll service defaults or otherwise fails to remit required deposits, the employer can remain responsible for the deposit of federal employment tax liabilities and the timely filing of returns.
This is why every company should establish an IRS Business Tax Account to provide access to crucial tax records, including a history of all payments. By monitoring this account regularly, responsible individuals can spot any irregularities in their payroll tax deposits early. Even start-ups with no taxable income and pass-through entities that do not pay income tax directly should set up an account at the IRS website (Business Tax Account).
The IRS website offers more information about the TFRP and the potential for personal liability for unpaid withholding taxes at Employment taxes and the Trust Fund Recovery Penalty (TFRP). All federal tax deposits must be made electronically via EFTPS or a Business Tax Account. The requirements and processes are spelled out in more detail in Section 11 of IRS Publication 15 (2025), Employer’s Tax Guide.
Please contact us if you have any questions about payroll tax compliance and reporting.
