The IRS Small Business/Self-Employed (SB/SE) Division has issued an internal memorandum which says that the “trust fund recovery penalty” (TFRP) may be imposed against third-party payroll service providers, as well as the employer [IRS Memorandum SBSE-05-0711-044, Issuing Interim Guidance for Trust Fund Recovery Penalty Investigations for Third-Party Payer Cases, 7/1/11].
Trust fund recovery penalty. Code Sec. 6672 imposes the trust fund recovery penalty on any person who: (1) is responsible for collecting, accounting for, and paying over payroll taxes; and (2) willfully fails to perform this responsibility. The amount of the penalty is equal to the amount of the tax that was not collected and paid. The penalty is imposed on a “responsible person.” A “responsible person” may be anyone in a business entity who has the duty to collect, account for, or pay over the tax.
Common law employers. The new IRS memorandum applies to “common law employers.” A “common law employer” is any person who has the status of employer under the usual common law rules applicable in determining the employer-employee relationship. Generally an employer-employee relationship exists when the person for whom the services are performed has the right to direct and control the worker who performs the services, not only as to the result to be accomplished by the work, but also as to the details and means by which that result is accomplished.
Third-party arrangements. Common law employers may designate a third party who is not the common law employer or a statutory employer under Code Sec. 3401(d)(1) to take over some or all of the employer's federal employment tax withholding, reporting, and payment responsibilities and obligations. A third party that could be subject to a TFRP includes: (a) a payroll service provider (PSP), or (b) a professional employer organization (PEO) or employee leasing company that is not the common law or statutory employer. The trust fund recovery penalty may be assessed against the payroll service provider, PEO, or responsible parties within the PSP or PEO.
A third-party payer is considered a responsible person under (1) above in Code Sec. 6672 if the person had significant control over the payment of its client's employment taxes. A third-party payer is considered to have willfully failed to perform the payroll tax responsibility (i.e., item (2) above) if failure to perform the responsibility was intentional, deliberate, voluntary, reckless, or knowing, as opposed to accidental. No evil intent or bad motive is required.
A common law employer that uses a third party to prepare its employment taxes can still be subject to the trust find recovery penalty if it meets conditions (1) and (2) above. Employees of the common law employer may also still be subject to the penalty.
Further information from the IRS. The IRS briefly discussed the memorandum during its July 14 payroll industry conference call. The IRS noted that it is still the employer that is ultimately responsible for the payment of any unpaid tax. However, the TFRP, depending on the circumstances, can be assessed against both the employer and the third-party payroll service provider, as there can be more than one responsible person. The total amount of the TFRP that the IRS assesses against all parties will not exceed the amount of the unpaid taxes.