A "100% penalty" can be assessed against a responsible person when federal income tax and/or federal employment taxes are withheld from employee paychecks but aren't handed over to the government.
This Trust Fund Recovery Penalty got its informal "100% penalty" moniker from the fact that the entire unpaid amount can be assessed against a responsible person (or several responsible persons). The purpose of the penalty is to collect withheld but unpaid federal taxes from individuals who had control over an employer's finances.
Often, operating a business as a corporation protects the individual owner from personal liability for some corporate debts. In cases of unpaid payroll taxes, however, the corporate shield or corporate veil is "pierced" and the IRS looks past the corporation to the responsible person to pay the debt.
Determining Who's Responsible
The 100% penalty can only be assessed against a responsible person. That could be a shareholder, director, officer or employee of a corporation; a partner or employee of a partnership; or a member (owner) or employee of a multi-member LLC. It can also be assessed against an employee of a sole proprietorship or an employee of a single-member (one owner) LLC. To be hit with the penalty, the individual must:
- Be responsible for collecting, accounting for, and paying withheld federal taxes, and
- Willfully fail to remit those taxes (willful means intentional, deliberate, voluntary and knowing, as opposed to accidental).
The mere authority to sign checks when directed to do so by a superior doesn't make a person responsible. There must also be knowledge of and control over the finances of the business. However, responsible person status can't be deflected simply by assigning signature authority over bank accounts to another person in order to avoid the 100% penalty. As a practical matter, the IRS will look first and hard at individuals with check-signing authority.
The courts have examined several factors beyond the authority to sign checks when they determined who had responsible person status. Those factors include whether the individual:
- Is an officer or director,
- Owns shares or has an entrepreneurial stake in the company,
- Is active in managing the day-to-day affairs of the company,
- Can hire and fire employees,
- Makes decisions regarding which, when, and in what order debts or taxes will be paid, and
- Exercises daily control over bank accounts and disbursement records.
Outside Parties Can Be Responsible
In certain circumstances, outside parties such as lenders and advisors can also be responsible persons. For example:
- A bank had the authority under a loan agreement with a delinquent corporation to oversee much of the corporation's operations. It exercised this authority by honoring some checks but dishonoring others and was found by the IRS to be a responsible person.
- A volunteer member of a charitable organization's board of trustees had knowledge of the organization's tax delinquency and authority to decide whether to pay the taxes. The individual was determined to be a responsible person by the IRS.
- The president of a day care center's board of directors, who wasn't paid for his work and wasn't involved in day-to-day operations, was held to be a responsible person because he secured loans for the center, directed its tax payments, and reviewed its financial reports. Therefore, he was found to be sufficiently involved in the center's financial affairs to make him a responsible person.
- The executor of a decedent's estate was found to be a responsible person when the operators of an inn (which was an asset of the estate) failed to remit withheld federal taxes.
More Real-Life Horror Stories
CEO and CFO Were Responsible Persons. A corporation's newly hired CFO became aware that the company was several years behind on its payroll taxes and notified the company's CEO of the situation. The CFO and CEO then informed the company's board of directors. Although the company apparently had sufficient funds, the taxes weren't paid. After the CFO and CEO were both fired, the IRS assessed the 100% penalty against them both for withheld but unpaid taxes accrued during their tenures.
The First Circuit Court of Appeals upheld an earlier district court ruling that the two officers were responsible persons who acted willfully by paying other expenses instead of the federal tax liabilities. Therefore, they were both personally liable for the 100% penalty. (Schiffmann, 117 AFTR 2d 2016-386 1st Circuit, 2016)
Vice President and Co-Owner Was Responsible Person. A 40% stockholder and vice president of a corporation had an agreement with the 40% owner and president that the VP wouldn't exercise independent authority over the corporation's finances. The VP was responsible for running the shop and field operations but had check-signing authority only if the president was out of the office or unavailable.
However, the VP typically signed the field workers' payroll checks and on one occasion signed the corporation's federal payroll tax report. The VP also signed an IRS form stating that he was aware of an unpaid liability for withheld federal employment taxes.
Despite the VP's argument that he had no real control over corporate finances and that he didn't focus on day-to-day administrative responsibilities, the Federal Court of Claims concluded that he had the authority and responsibility to oversee the company's financial obligations. Therefore, he was found to be a responsible person and was personally on the hook for the 100% penalty. (Waterhouse, 116 AFTR 2d 2015-5080 Court of Federal Claims, 2015)
If you can be held personally liable for failure to remit withheld employment taxes — whether or not you're an owner or officer of the company — make sure that Uncle Sam is paid in a timely fashion. And keep in mind that in some cases, the IRS can go after several people.
If you're tagged, you may ultimately prove that you aren't a responsible person, but that could be expensive. Consult with your tax advisor about what records you should be keeping to avoid exposure to this expensive penalty.
Not Paying Over Employment Taxes Can Even Lead to Prison
In one case, the president of a construction company was sentenced to 18 months in prison for employment tax fraud and ordered to pay restitution to the IRS in the amount of $677,350, according to the U.S. Department of Justice (DOJ).
The 52-year-old man failed to collect, account for and pay over employment taxes to the IRS. The DOJ stated in a press release that he "chose to withhold employment tax from his employees, and use those funds for his personal benefit, inflicting substantial harm on the U.S. Treasury and gaining a competitive advantage over his law-abiding competitors."
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