Does your business have unpaid employment tax liabilities? If you answered yes, it is important to consider designating voluntary payments towards trust fund taxes. Designating payments costs you nothing, and helps you avoid personal liability. If you do not designate your payments, the IRS will apply the payments in a manner that is least beneficial to you.
Why should you designate payments towards trust fund taxes?
Employment taxes are grouped into two general categories—trust fund taxes and non-trust fund taxes. Trust fund taxes are those amounts that you withhold from an employee's wages (income tax, Social Security, and Medicare taxes). Since you have withheld these amounts from your employee's wages, you are considered to be holding them “in trust” for the employee. As the employer, you are required to remit these withheld amounts to the IRS through the Federal Tax Deposit System. The employer's share of employment taxes—Social Security, Medicare, and Federal Unemployment Tax—are considered non-trust fund taxes.
It is important to know the difference between trust fund taxes and non-trust fund taxes because the potential to be personally liable for taxes differs. You may be personally liable for trust fund taxes, but you generally are not personally liable for non-trust fund taxes (with some exceptions). Interest and penalties — i.e., additions to tax — are not considered to be trust fund taxes even when they are interest on and penalties for late payment of trust fund taxes. See Stevens v. United States, 49 F.3d 331 (7th Cir. 1995).
When a company in financial distress owes both trust fund and non-trust fund taxes, it is in the best interest of any potential responsible person to have tax payments made by the company designated first to the trust fund taxes. Otherwise, the responsible person is personally liable for the payment of trust fund taxes, even if the company subsequently files for bankruptcy.
Designating payments towards trust fund taxes avoids potential civil liability, but more importantly, it avoids criminal liability. Civil and criminal employment tax enforcement is among the Department of Justice Tax Division's highest priorities. The government perceives businesses that withhold money from their employee's paychecks for payment of taxes as stealing from employees when they do not remit those monies to the government.
Unpaid employment taxes are a substantial problem. Amounts withheld from employee wages represent nearly 70% of all revenue collected by the IRS and, as of June 30, 2016, more than $59.4 billion of tax reported on Employer's Quarterly Federal Tax Returns (Forms 941) remained unpaid. According to the Department of Justice, employment tax violations represented more than $91 billion of the gross Tax Gap and, after collection efforts, $79 billion of the net Tax Gap in this country.
What happens if you make a payment without designating trust fund taxes?
When you make a payment to the IRS, the IRS has no obligation to minimize the potential liability that a responsible person faces with trust fund taxes. The IRS's policy is to apply both undesignated and involuntary payments to eliminate non-trust fund liability first and only then to the trust fund tax liability. IRS Policy Statement 5-14, at IRM 18.104.22.168.3. A payment made by a business is considered to be a payment toward the non-trust fund portion of the taxes (including assessed and accrued penalties and interest) unless the business specifically designates that the payment is for trust fund taxes. Westerman v. United States, 718 F.3d 743 (8th Cir. 2013). This means that if your business makes a payment without designating trust fund taxes, the IRS will apply the payment to non-trust fund taxes and pursue responsible persons for the trust fund taxes.
How do you designate payments towards trust fund taxes?
There are two requirements that must be met before the IRS will respect a payment designation:
- The payment must be voluntary.
- The request for the application of the payment must be specific, in writing, and made at the time of the payment.
Rev. Proc. 2002-26.
A voluntary payment is any payment that is not considered involuntary, and an involuntary payment is any payment received as a result of levy, seizure, or from a legal proceeding in which the government seeks to collect its delinquent taxes. Stevens v. United States, 49 F.3d 331 (7th Cir. 1995); IRS Policy Statement 5-14. No designation can be made in the case of collections resulting from enforced collection measures. Installment agreement payments are considered involuntary payments and will be applied in the order of priority that the IRS determines will serve its best interest. Rev. Proc. 2002-26. Generally, that means to the oldest non-trust fund taxes, penalties, and interest. Payments made in bankruptcy are deemed to be involuntary payments. See, e.g., In re DuCharmes & Co. v. United States, 852 F.2d 194 (6th Cir. 1988); In re Technical Knockout Graphics, Inc., 833 F.2d 797 (9th Cir. 1987); In re Ribs-R-Us, Inc., 828 F.2d 199 (3d Cir. 1987).
A designation may be made by simply writing “trust fund taxes” on the memo line of a check along with the tax period (quarter and year). As long as the payment is voluntary, this instruction on the memo line of a check will satisfy that the designation be specific, in writing, and made at the time of payment.
If your business is experiencing financial difficulty and having trouble meeting its employment tax liabilities, be sure that any voluntary payments are properly designated towards trust fund taxes and setup a consultation with Brandon Keim for other opportunities to minimize your civil and criminal exposure.