Trust Fund Recovery Penalty: Personal Liability Explained
Why unpaid withholding follows the owner personally, who counts as a responsible person, and how the 100 percent penalty is assessed
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
The trust fund recovery penalty makes any "responsible person" personally liable for payroll taxes an employer withheld from employees but did not pay over to the IRS — income tax withholding and the employees' share of Social Security and Medicare. The penalty equals 100 percent of the unpaid trust fund taxes, is assessed against individuals, and no entity shields it.
On this page
What are trust fund taxes?
Of the taxes on Form 941, part is the employer's own (the employer's 7.65 percent share of Social Security and Medicare, plus FUTA) and part is money the employer took out of employees' paychecks and holds for the government: federal income tax withholding and the employees' 7.65 percent share. That second part is the trust fund portion. The law treats it as held in trust — it was never the employer's money — and an employer that uses it to pay rent, suppliers, or itself has, in the IRS's framing, spent the employees' tax payments. The employees get credit for the withholding on their own returns regardless, so the government is out the money and pursues whoever was responsible.
Who is a responsible person?
Anyone with the duty to collect, account for, and pay over the taxes and the authority to decide which bills get paid — a status decided by function, not title. Typically: the owner, officers, and directors of a corporation; members and managers of an LLC; partners; a controller, CFO, or office manager who signs checks and chooses payees; and in some cases a bookkeeper, a lender exercising control over payments, or an outside payroll company that took the money and didn't deposit it. Several people can be responsible at once, and the IRS may assess each of them for the full amount (collecting only once in total). A silent investor with no check-signing authority is not responsible; a "title-only" officer who in fact controlled payments is.
| Indicates responsibility | Does not by itself |
|---|---|
| Signing payroll or vendor checks; authority over which creditors are paid | Being listed as an officer with no financial role |
| Ownership with control over finances | Preparing the payroll under someone else's direction |
| Hiring and firing authority; control over the bank accounts | Being an employee who knew about the problem but had no authority |
| Deciding to pay suppliers or rent while payroll taxes went unpaid | Holding a minority interest with no management role |
What is willfulness?
Willfulness does not require intent to defraud. It means the responsible person knew (or recklessly disregarded that) the trust fund taxes were unpaid and paid other creditors instead. Paying the landlord, the suppliers, or the owner's own draw while the payroll taxes sat unpaid is willful. Continuing to run payroll after learning the deposits were missed — and still not catching them up — is willful. An owner who genuinely didn't know because a payroll provider embezzled the deposits may not be willful for the period before discovery, but becomes willful the moment they learn and don't act.
How is the penalty assessed?
The IRS interviews the potentially responsible persons (Form 4180), sends each a proposed assessment letter (Letter 1153), and — after a 60-day window to appeal — assesses the penalty against each individual. It then collects from the individuals with the same tools it uses against any tax debt: liens, levies on personal bank accounts and wages, and offset of personal refunds. The penalty is not dischargeable in bankruptcy, and the ten-year collection statute runs from the individual assessment. The business's own liability for the same taxes continues in parallel; payments by the business or any responsible person reduce everyone's balance.
How does it interact with an LLC or corporation?
It doesn't respect the entity. Every entity guide on this site describes the LLC as the liability floor — and it is, for contract and tort claims. Payroll trust fund taxes are the exception: the assessment runs to the individuals who controlled the money. This is why the payroll deposit is the one business obligation to pay before any other, including the owner's own salary, and why an owner who is short on cash should file the 941 on time, pay what can be paid toward the trust fund portion first (designating the payment in writing), and address the employer's share second.
How is it avoided or resolved?
Avoided by depositing on schedule through EFTPS (the deposit schedule guide), monitoring a payroll provider's deposits in the employer's own EFTPS account, and never using withheld taxes as working capital. Resolved — once behind — by paying the trust fund portion first with a written designation, requesting an installment agreement for the business, and presenting the responsible-person and willfulness facts in the interview and appeal honestly; the penalty can be contested on either ground, and the IRS's own interest is in collecting the trust fund amount once, from whichever source pays.
Worked example
A restaurant LLC with two members falls behind: over three quarters it withholds US$64,000 of income tax and employee Social Security and Medicare from its staff but deposits only US$20,000, using the rest to keep suppliers paid; the employer's share is another US$28,000. The IRS applies undesignated deposits to the employer's share first, so the US$20,000 leaves US$8,000 of employer share and all US$64,000 of trust fund tax unpaid. It assesses the business for the full US$72,000 plus penalties and interest — and proposes the trust fund recovery penalty of US$64,000 (the unpaid trust fund portion) against both members: the managing member who signed every check, and the second member who had check-signing authority and knew of the shortfall by the second quarter. Both are responsible; both were willful. The LLC's liability protection is irrelevant to the US$64,000, which the IRS can collect from either member's personal assets. A payment of US$64,000 by anyone clears the penalty for both; the business still owes the remaining US$8,000 employer share and its own penalties.
Frequently asked questions
What is the trust fund recovery penalty?
A penalty equal to 100 percent of the payroll taxes withheld from employees but not paid to the IRS, assessed personally against each responsible person who willfully failed to pay them over.
Who is a responsible person?
Anyone with the duty and authority to collect, account for, and pay the taxes — owners, officers, LLC members, and financial managers who control which bills are paid. Function controls, not title; several people can be responsible at once.
Does an LLC protect me from it?
No. The penalty is assessed against individuals, not the entity. Limited liability protects against the business's contract and tort debts, not against personal liability for trust fund taxes.
Can it be discharged in bankruptcy?
No. Trust fund recovery penalty liabilities are not dischargeable in personal bankruptcy.
Official sources
The IRS states: “A responsible person is a 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.” — Internal Revenue Service, Employment taxes and the trust fund recovery penalty, https://www.irs.gov/businesses/small-businesses-self-employed/employment-taxes-and-the-trust-fund-recovery-penalty-tfrp
The IRS states: “You must deposit and report federal income tax and Additional Medicare Tax withheld and both the employer and employee social security and Medicare taxes.” — Internal Revenue Service, Employment taxes, https://www.irs.gov/businesses/small-businesses-self-employed/employment-taxes
Next step
Fairlight Accounting is a cross-border accounting and tax practice with a U.S. Tax Desk and a Canadian Tax Desk. Our U.S. Tax Desk handles payroll tax delinquency triage — trust fund designation of payments, installment agreements, responsible-person interview preparation, and deposit-compliance systems. See pricing or book a call.
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