Internal Revenue Code Section 6672 liability is referred to as the “Trust Fund Recovery Penalty” or “Civil Penalty” and is the legal basis for the federal government to collect “trust fund” taxes. In the context of employment taxes, the term “trust fund” taxes refer only to taxes withheld from employees for the payment of federal income tax and one-half of the Federal Insurance Contributions Act (FICA) that fund Social Security and Medicare programs. Such taxes are reported on the Form 941 tax return that is filed by an entity with W2 employees on a quarterly basis and reports the gross wages paid, the federal income tax withheld, the sum of employer’s and employees’ FICA liability, and the deposits paid. After the deposits (if any) are accounted for, the taxes still owing are to be paid with the return. The unpaid balance due from these taxes may be the subject of a Section 6672 assessment.
Section 6672 allows the IRS to collect the unpaid trust fund tax liabilities of corporations and other types of limited liability entities from the personal assets of those persons who were responsible for the non-payment of such taxes to the government. Thus, the veil of the entity will not protect the income and assets of the individual from collection of a Trust Fund Recovery Penalty assessment.
The factual pattern is usually one where an entity is suffering financial strain and is unable to pay its creditors for the purpose of remaining operational. Thus, the owners and/or officers of the entity divert the payroll taxes withheld to pay non-IRS creditors instead of forwarding the money to the IRS to pay the payroll tax debts. The individuals who made the decision to divert the money can be held personally liability for the payroll tax debts.
Trust fund deficiencies may be assessed against several persons for the same tax period liabilities owing. The policy permitting joint and several liability is to assert the penalty for collection purposes and allow the individuals to dispute the collection of the penalty assessment among themselves. However, the IRS cannot collect more trust fund taxes than are owed by the business. In the case of overpayment, the last person to pay the trust fund debt owed that caused the overpayment is entitled to a refund. Internal Revenue Manual Section 184.108.40.206.
Generally, a Section 6672 assessment will be assessed when:
1. The individual was a responsible person (someone who has the status, duty, and authority over the financial decision-making) within the liable entity; and
2. The individual willfully failed to collect, truthfully account for, and pay over trust fund taxes (by knowingly paying other creditors while the trust fund taxes were due to the IRS).
The determination of who is a responsible person has been defined by administrative rulings and case law, not the Internal Revenue Code. Responsibility attaches when a person has the authority to decide which creditors to pay and when to pay them (or not pay them).
The element of willfulness has been defined by case law and the Internal Revenue Manual, not the Internal Revenue Code. Willfulness for Section 6672 purposes merely requires a voluntary, conscious, and intentional decision not to remit funds properly withheld to the government.
Internal Revenue Manual, Section 220.127.116.11 reads that the Section 6672 penalty “will normally not be assessed when the likelihood of successful collection is minimal.” Therefore, in practice, the determination of whether a Section 6672 assessment should be made is a three element test that includes potential collectibility, when Section 6672 is read together with Internal Revenue Manual Section 18.104.22.168.
The IRS generally has three years to assess the Trust Fund Recovery Penalty. Civil Penalty assessments are usually investigated and proposed by a Revenue Officer in the IRS Collection Division. If a Trust Fund Recovery Penalty investigation cannot be avoided by resolving the outstanding payroll liabilities, the Revenue Officer will normally examine the entity’s tax returns, bank records, signature cards, Articles of Incorporation, Bylaws, canceled checks, corporate minutes, and corporate resolutions to establish the responsibility and willfulness elements needed for assessment.
Revenue Officers will also attempt to interview individuals who may have knowledge of the entity’s decision making processes and financial condition. Revenue Officers will then attempt to conduct Form 4180 interviews with those individuals who may have had a role in diverting the money. The Form 4180 interviews are designed to elicit admissions to support that a Section 6672 assessment is warranted.
If the Revenue Officer’s recommendation for assessing a Trust Fund Recovery Penalty is approved by the Revenue Officer’s group manager, a 60-day letter is issued to those taxpayers that were deemed responsible for diverting the money. The 60-day letter notifies them of the proposed assessments. After receiving a 60-day letter, a taxpayer may dispute the penalty prior to it being assessment (pre-assessment appeal) or after it has been assessed (post-assessment appeal). One difference between the two options is that interest will not accrue if the appeal is made before the penalty is assessed. If a taxpayer does not provide a response within the required 60 days, the Revenue Officer will assess the Trust Fund Recovery Penalty and the IRS will begin to pursue collection efforts against the taxpayer. The taxpayer can then either pay the penalty or pursue a resolution with the IRS.