Payroll Tax Debt and Personal Liability for Owners

Many business owners believe that forming a corporation or LLC keeps business debts away from their personal finances. For most debts, that may be close to true. Unpaid payroll taxes are different. Part of those taxes can be collected from individuals personally, through a penalty the IRS calls the Trust Fund Recovery Penalty (TFRP). This guide explains the basics in plain language so you can understand a notice and know what to ask.

Why payroll taxes are treated differently

The IRS explains on its understanding employment taxes page that employers generally must withhold federal income tax from employees' wages, withhold Social Security and Medicare taxes, and pay the employer's share of those taxes. Employers must then deposit and report these taxes on time.

The amounts taken out of employees' pay belong, in effect, to the government. The business holds them "in trust" until it deposits them. When a business is short on cash and uses that withheld money to pay rent, suppliers, or even net wages, the IRS can look beyond the business to the people who made those decisions.

What the Trust Fund Recovery Penalty is

The IRS's own manual for its Appeals office, IRM 8.25.1, describes the TFRP in detail. According to that manual:

• The authority for the penalty is section 6672 of the Internal Revenue Code.
• The penalty applies to any responsible person who willfully fails to collect, account for, or pay over taxes held in trust.
• The penalty equals the total amount of the trust fund tax not collected or not paid over.
• It applies to the employees' portion of employment taxes, meaning withheld income tax and the employees' share of Social Security and Medicare taxes. It does not apply to the employer's own share.
• It can also apply to collected excise taxes.

So the business may still owe the full payroll tax debt, while one or more individuals may be personally liable for the trust fund part.

Who can be a "responsible person"

The IRS manual says most TFRP cases involve officers of corporations, but a responsible person may also be, among others:

• An officer or employee of a corporation.
• A member or employee of a partnership.
• A corporate director or shareholder.
• An LLC member, manager, or employee.
• An employee of a sole proprietorship.
• A payroll service provider or professional employer organization, or a responsible person within one.
• A lender, surety, or other person with enough control over funds to direct how they are spent.

The manual lists factors courts have looked at, such as holding a corporate office, control over financial affairs, authority to pay out company funds, stock ownership, and the ability to hire and fire. These are weighed together, so the answer depends on what each person actually did and could do.

The manual also notes that using a payroll service provider or a professional employer organization does not by itself relieve the employer, and the employer's responsible people, of the duty to make sure the taxes are paid.

What "willful" means here

This is the part that surprises many owners. The IRS manual explains that the TFRP is a civil penalty, so the level of willfulness needed is lower than in a criminal case. It describes willfulness as intentional, deliberate, voluntary, and knowing, as opposed to accidental. The manual states there is no need to show evil intent or a desire to defraud the government.

According to the manual, examples that can count as willful include:

• Paying net wages to employees when there is not enough money to also pay the withholding taxes.
• Paying other bills while knowing the payroll taxes were unpaid.
• Failing to look into or correct the problem after learning the taxes were not paid.

The 60-day letter and your appeal rights

Before the IRS assesses the TFRP, it must send a notice of proposed assessment called Letter 1153. The IRS manual explains that this letter tells you about the proposed penalty and your appeal rights. You generally have 60 days from the mailing date (or delivery date, if handed to you) to file a protest and ask for an Appeals review, or 75 days if the letter was addressed outside the United States.

This deadline matters. The manual states that the 60-day period cannot be restarted by the IRS simply reissuing the letter with a new date. If you receive Letter 1153, note the date right away and talk to a professional quickly.

What to do if your business is behind on payroll taxes

• Stop the problem from growing. Each pay period without deposits can add to the debt. The IRS describes deposit and filing requirements for employers.
• Keep filing returns. Filing on time, even when you cannot pay in full, keeps the record clear.
• Gather records. Bank signature cards, bylaws or operating agreements, emails about which bills to pay, and payroll reports can all matter.
• Ask about payment options. The IRS describes payment plans and installment agreements on its site. Eligibility depends on your situation.
• Answer IRS contacts. An interview with a revenue officer can shape who is found responsible. Consider getting advice before it happens.

When to talk to a tax lawyer

Payroll tax problems can involve both the business and individuals, and their interests may not be the same. A tax lawyer can explain your exposure, help you prepare for an interview, and respond to a Letter 1153. A business lawyer may also help if the company is restructuring or closing.

If cost is a concern, USAGov's page on resolving tax disputes describes the Taxpayer Advocate Service and Low-Income Taxpayer Clinics, which may offer free or low-cost help.

Frequently asked questions

Can I be personally liable for my company's payroll taxes if I have an LLC?

Possibly. The IRS manual lists LLC members, managers, and employees among people who may be responsible persons. It depends on your role and actions.

Does the penalty cover the full payroll tax bill?

No. It covers the trust fund portion, meaning withheld income tax and the employees' share of Social Security and Medicare, not the employer's share.

How long do I have to respond to Letter 1153?

Generally 60 days from mailing or personal delivery, or 75 days if addressed outside the United States.

Can more than one person be held responsible?

Yes. The IRS manual notes that cases can involve two or more officers of the same company.

Related: Browse more legal guides and tax lawyers.

General information, not legal advice. Laws change and every case is different — talk to a licensed attorney about your situation.