I recently had a conversation with a colleague concerning an IRS trust fund penalty case he had and was pleased that he had success with a little known footnote in the Internal Revenue Manual (IRM) which may save money for a company officer who would otherwise be liable for a payroll trust fund recovery penalty (TFRP).
The issue is this: A business must make tax deposits for employment taxes (which must be done electronically ever since 2011). A responsible person (usually an officer or manager of an employer entity) who is found to have acted “willfully” in not making the deposits can be held personally liable for the withheld portion of the payroll taxes. If no deposits were made for a whole quarter or more the trust fund portion is easy enough to calculate. But suppose an employer made, say, two deposits at the beginning of a quarter, and suppose the deposits included both the employee trust fund portion and the matching employer FICA/Medicare amounts. Is the IRS required to apply the first two deposits to both the trust fund and the non trust fund portions or may the IRS apply the entirety of the two deposits to the employer share only?
While the IRS prefers to and often does calculate the trust fund amount by applying the first two deposits entirely to the employer share, which maximizes the unpaid trust fund amount, it turns out that a brief note in the the IRM requires the Service to respect the employer’s deposits if the employer establishes that the particular deposits were made in accordance with the deposit rules set out in Treas. Reg. 31.6302-1. This is the Treasury regulation which sets out the deposit rules for taxes under the Federal Insurance Contributions Act (FICA) and withheld income taxes. The IRM excerpt states that:
If the taxpayer established that a deposit was in the amount required by Treasury Regulation 31.6302–1 (after December 31, 1992, with allowance for the safe harbor rule), the FTD will be applied to 1 and 2 for the specific period covered by the FTD, even before June 19, 2000. The taxpayer must provide payroll records that show the composition of the FTD and that the FTD was timely. The records must reflect exactly how much of the FTD was employer FICA, employee FICA, and income tax withheld. The procedures on ATFR for using designated (split) TC 650 payments should be used in these types of case
(1) referred to above is the employer non trust fund portion and (2) is the trust fund portion. Because electronic EFTPS payroll deposits allow, although they do not require, a taxpayer to fill in boxes online showing the portion of each deposit which is being made for both trust fund and employer shares, the employer who fills in the boxes should have a leg up in showing the composition of the deposit. However, it may be necessary to also have payroll records which will independently establish the amount of the payroll and taxes for which the timely deposit was made.
In the case I discussed with my colleague there were two timely deposits made, and thereafter several checks properly designated “for trust fund only” were hand delivered to a local IRS office for the remainder of the quarter. From the individual officer perspective there was no trust fund due because the combination of the two timely deposits and the later designated checks fully paid the trust fund amount. However, the revenue officer calculated the trust fund balance by applying the amount of the two tax deposits to the employer obligation only, which created a $100,000 trust fund balance for which the officer proposed a TFRP. My colleague appealed, and on the strength of the IRM provision the proposed TFRP was reversed.
This this is a good point in the right situation, but remember that if no deposits are made the rule has no application. Since trust fund cases by definition involve situation where no deposits have been made, the benefits of the rule are likely to come into play only with the deposits in a quarter where the employer first began to default in payments. But if the payroll is a fairly large one, and some deposits have been timely and correctly made before the defaults occurred, the rule might save the otherwise responsible officer a bundle of money.