According to a memorandum issued by the IRS Small Business/Self-Employed Division (SB/SE), the Trust Fund Recovery Penalty (TFRP) under Internal Revenue Code (IRC) Section 6672 may be imposed against third-party payers, such as payroll service providers (PSP) and professional employer organizations (PEO), that fail to pay over to the IRS withheld payroll taxes.
On July 1, 2011, SB/SE issued a memorandum titled “Interim Guidance for Conducting Trust Fund Recovery Penalty Investigations in Cases Involving a Third-Party Payer.” The memorandum expands the scope of “responsible persons” under IRC Section 6672 to include third-party payers, such as PSPs and PEOs, and is consistent with recommendations made by the IRS National Taxpayer Advocate in her 2004 Report to Congress regarding protecting businesses from misappropriations by PSPs. See National Taxpayer Advocate, 2004 Annual Report to Congress 394-99 (2004).
As explained in “Failure to Pay Over Payroll Taxes Could Land You in Jail,” employers who fail to pay over to the IRS withheld income and FICA taxes may face criminal penalties, as well as the TFRP. In many cases, however, employers engage a PSP to process the payroll and ensure employment tax compliance. In 2003 and 2004, there were several high-profile cases in which the PSPs failed to pay over to the IRS the payroll taxes, even though the employees’ shares were withheld from their wages and the employers’ provided the PSPs with their share of the payroll taxes. In some cases, the PSPs went out of business, leaving the employers with an outstanding liability for the taxes that were never paid to the IRS. This left the employers with having to pay twice: once to the PSP, and again to the IRS.
Under IRC Section 6672, the IRS can collect the payroll taxes that were withheld from the employees’ wages but not paid over to the IRS from any “responsible person.” By expanding the scope of responsible person to include third-party payers, such as PSPs and PEOs, the SB/SE memorandum opens the door to collecting the withheld payroll taxes from PSPs and PEOs that fail to pay over such taxes. More importantly, officers, directors, employees, and owners of PSPs and PEOs who are responsible persons may be personally liable for the TFRP.
While IRC Section 6672 authorizes the IRS to collect the full amount of the withheld payroll taxes from more than one responsible person, it only collects the tax once. If the IRS is able to collect the TFRP from a PSP or PEO or their responsible persons, the employer and its responsible persons should not be required to pay for the withheld payroll taxes that were not paid over to the IRS. This helps employers who entrusted their employment tax compliance to a third-party payer.
The SB/SE memorandum cautions that each recommendation for assertion of the TFRP against a third-party payer must stand on its own merits based on the facts the revenue officer discovers during its investigation. A third-party payer may only be liable as a responsible person for a violation of IRC Section 6672 if that violation was “willful.” Accordingly, SB/SE memorandum identifies factors that should be considered in determining whether the third-party payer’s failure to pay over the withheld payroll taxes was willful.
PSPs play a very important roll for businesses, especially small businesses, in processing payroll and complying with employment tax requirements. Most PSPs are professional, competent, and scrupulous in ensuring that payroll taxes are paid over to the IRS. While it is important to eliminate bad actors from the third-party payer industry by giving the IRS more authority to sanction them for failing to comply with the law, exposing officers, directors, employees, and owners of all third-party payers to personal liability under the TFRP adds a new dimension to the employment tax landscape.