The trust fund recovery penalty and LLCs

Unpaid payroll taxes are often liabilities of a business in bankruptcy. The payroll tax liability is created when the employer withholds income tax and the employees' share of FICA (collectively called the trust fund taxes) from employees but has not yet paid the withheld amounts to the IRS.

Under Sec. 6672, any person who is required by law to collect, account for, and pay over any tax, and who willfully fails to do so, is liable for a penalty equal to the total amount of the tax (the trust fund recovery penalty (TFRP)). This penalty applies to responsible persons for willful nonpayment of withheld trust fund taxes to the government. (The failure to pay over trust fund taxes does not harm the employee, who is given full credit for the amounts that should have been turned over to the government.)

The IRS is prohibited from assessing the TFRP against a taxpayer without 60-day notice that the taxpayer is subject to an assessment of the penalty, unless the collection of the penalty is in jeopardy. An extension of the statute of limitation is also provided, to the later of:

• 90 days after the date on which the notice was mailed or delivered in person; or
• If there is a timely protest of the proposed assessment, 30 days after the IRS makes a final administrative determination on the protest.

Practice tip: In Chief Counsel Advice (CCA) 200532046, the IRS concluded that the statute of limitation on the assessment of the TFRP is the same as that of the underlying employment obligations. Thus, if the underlying obligation's statute of limitation is indefinitely extended because of fraud, the TFRP's statute of limitation is also indefinitely extended.

A responsible person is any person who is connected or associated with the limited liability company (LLC) in such a manner that he or she has the power to see that the trust fund taxes are paid. Responsible persons can include managers and member-managers. As a practical matter, the IRS views check-signing authority as proof an individual is a responsible person. However, this may not be the case if the individual rarely signs checks. While not conclusively proving responsibility, the ability of a member or manager to sign checks makes it difficult to overcome the IRS's presumption that the member, manager, or employee is a responsible person. While this is a facts-and-circumstances determination, the IRS considers certain factors in deciding which individuals are or could be responsible persons (Internal Revenue Manual (IRM) §5.7.3.3.1).

A responsible person may be subject to the TFRP if it can be shown he or she willfully failed to pay the trust fund taxes due. Unfortunately, a responsible person cannot delegate the authority for payment of trust fund taxes to a third party, thereby avoiding the penalty. If there is more than one responsible person, the failure of one to timely pay trust fund taxes does not excuse the failure of another responsible person.

Caution: In certain circumstances, outside parties, such as lenders, attorneys, and accountants can also be responsible persons. In Quattrone Accountants, Inc., 895 F.2d 921 (3d Cir. 1990), an accounting firm was found to be a responsible person when it prepared a corporation's tax returns, discussed the company's budget and financial status with the president, and authorized the payment of corporate bills without prior approval. In Erwin, No. 1:06CV59 (M.D.N.C. 2/5/13), outside accountants were held liable for unpaid trust fund taxes because they had direct access to the company's operating account, the authority to make the electronic transfers to the IRS, and the ability to write checks for the company—and they were never instructed not to pay the payroll taxes.

Since the TFRP is assessed personally against a responsible individual, the liability protection offered by an LLC does not apply. Furthermore, the TFRP is not deductible for income tax purposes and is nondischargeable in bankruptcy. Consequently, in a Chapter 7 bankruptcy proceeding, the LLC's responsible persons are liable for the 100% penalty for any trust fund taxes unpaid at the time the LLC is liquidated. In a Chapter 11 proceeding, IRS policy generally permits payment of the trust fund taxes as part of the bankruptcy, assuming the LLC's approved plan of reorganization provides for the payment of the taxes.

In CCA 200235023, the IRS Chief Counsel noted that determining liability for an LLC's taxes depends on its classification election. If a multiple-member LLC elects to be taxed as a corporation, the LLC is liable for the tax, but the members (owners) of the LLC may be liable for the TFRP. If there has been no corporate election, a multiple-member LLC is taxed as a partnership. Unlike the typical partnership situation, where the IRS asserts an employment tax liability against the partners (who are liable for the partnership's debts under state law), the IRS will not assert an employment tax liability against the members because they are not liable for debts of the LLC under state law. However, the members may be liable for the TFRP.

If a single-member LLC (SMLLC) elects to be taxed as a corporation, the LLC is liable for the tax, but the single-member owner (and others) may be liable for the TFRP. If there has been no corporate election, the LLC is disregarded for most federal tax purposes. An SMLLC is not treated as a disregarded entity for employment tax purposes. To collect from the individual member, the IRS has to assess the TFRP.

While the IRS cannot look to the LLC's assets to satisfy the single-member owner's tax liability, it can take collection action against the member's ownership interest in the LLC, thus achieving the same result indirectly. (See also CCA 200338012.)

According to Rev. Rul. 2004-41, if under state law the members of an LLC are not liable for the debts of the LLC, then, absent fraudulent transfers or other special circumstances, the IRS cannot collect the LLC's employment tax liability from the members. However, "depending on the facts of a particular case, a member may be liable for the [TFRP]."

The TFRP can be assessed against more than one member, member-manager, manager, or LLC employee. Each responsible person is jointly and severally liable for the trust fund taxes and, therefore, can be assessed 100% of the unpaid trust fund taxes. However, a federal right of contribution exists. Consequently, any person paying more than a proportional share of the penalty has the right to recover from other responsible persons their proportional shares of the penalty, although this will probably involve suing the other members for their proportional share.

This case study has been adapted from PPC's Guide to Limited Liability Companies, 22d edition, by Michael E. Mares, Sara S. McMurrian, Stephen E. Pascarella II, and Gregory A. Porcaro. Published by Thomson Reuters/Tax & Accounting, Carrollton, Texas, 2015 (800-431-9025; tax.thomsonreuters.com).