Could you be hit with the Trust Fund Recovery Penalty?
There’s a harsh tax penalty that you could be personally responsible to pay if you own or manage a business with employees. It’s called the Trust Fund Recovery Penalty. It applies to the Social Security and income taxes required to be withheld by a business from the wages of its employees.
Because taxes are considered property of the government, the employer holds them in “trust” on the government’s behalf until they’re paid over. The penalty is also sometimes called the “100% penalty” because the person liable and responsible for the taxes can be penalized 100% of the taxes due. Accordingly, the amounts the IRS seeks when the penalty is applied are usually substantial, and the IRS is aggressive in enforcing the penalty.
A wide-reaching penalty
The Trust Fund Recovery Penalty is among the more dangerous tax penalties because it applies both to a broad range of actions and to a wide range of people involved in a business.
Here are some questions and answers to help you avoid incurring the penalty.
What actions are penalized? The Trust Fund Recovery Penalty applies to willful failures to collect or truthfully account for and pay over Social Security and income taxes required to be withheld from employees’ wages.
Who is at risk? The penalty can be imposed on anyone “responsible” for collection and payment of the tax. This has been broadly defined to include corporate officers, directors and shareholders who are under a duty to collect and pay the tax, and a partnership’s partners or any employee of the business with such a duty. Even voluntary board members of tax-exempt organizations, who are generally exempt from responsibility, may be subject to this penalty under certain circumstances. In some cases, responsibility has even been extended to family members close to the business, and to attorneys and accountants.
According to the IRS, responsibility is a matter of status, duty and authority. Anyone with the power to see that the taxes are (or aren’t) paid may be responsible. There’s often more than one responsible person in a business, but each is at risk for the entire penalty. You may not be directly involved with the payroll tax withholding process in your business. But if you learn of a failure to pay over withheld taxes and you have the power to pay them but instead you make payments to creditors and others, you become a responsible person.
Although a taxpayer held liable can sue other responsible people for contribution, this action must be taken after the penalty is paid, entirely on his or her own. It isn’t part of the IRS collection process.
What is considered “willful?” For actions to be willful, they don’t have to include an overt intent to evade taxes. Simply bending to business pressures and paying bills or obtaining supplies instead of paying over withheld taxes that are due to the government is willful behavior. The IRS specifically defines “willfully” in this instance as “voluntarily, consciously and intentionally” paying other expenses instead of the withholding taxes.
Just because you delegate these responsibilities to someone else doesn’t necessarily mean you’re off the hook. Your failure to deal with the task yourself can be treated as the willful element.
Never borrow from taxes
Under no circumstances should you ever fail to withhold taxes or “borrow” from withheld amounts. All funds that have been withheld from employee paychecks should be paid over to the government in full and on time. Contact us with any questions about making tax payments.
Taking casualty loss tax deductions is now harder
Unexpected disasters such as severe storms, flooding and wildfires can happen anywhere, causing damage to your home and personal property. Before the Tax Cuts and Jobs Act (TCJA), eligible casualty loss victims could claim a deduction on their tax returns. But restrictions make it tougher to qualify for these deductions.
What’s considered a casualty for tax purposes? It’s a sudden, unexpected or unusual event, such as a hurricane, tornado, flood, earthquake, fire, act of vandalism or terrorist attack.
Higher hurdles to qualify
The TCJA generally eliminates deductions for personal casualty losses through 2025, unless the losses are due to a federally declared disaster. So, victims in several presidentially declared major disaster areas in 2021 would be eligible for casualty loss tax deductions.
Note: An exception to the general rule states that if you receive insurance proceeds that result in a personal casualty gain, you can deduct personal casualty losses up to the amount of the gain, even without a federal disaster declaration.
If your casualty loss is due to a federally declared disaster, a special election allows you to deduct the loss on your tax return for the preceding year and claim a refund. If you’ve already filed your taxes for that year, you may file an amended return and elect to claim the deduction for the earlier year. This may help you get extra cash when you need it.
The election must be made no later than six months after the due date (without extensions) for filing your tax return for the year in which the disaster occurs. However, the election itself must be made on an original or amended return for the preceding year.
Calculating the deduction
These three steps must be taken to calculate the casualty loss deduction for personal-use property in an area declared a federal disaster:
- Subtract any insurance proceeds,
- Subtract $100 per casualty event, and
- Combine the results from steps 1 and 2, then subtract 10% of your adjusted gross income for the year you claim the loss deduction.
Be aware that another factor that complicates your ability to claim a casualty loss is that you must itemize deductions to do so. The TCJA raised the standard deduction through 2025 (for 2022, it is $12,950 for single filers, $19,400 for heads of household and $25,900 for married couples filing jointly). A higher standard deduction means fewer individuals will itemize deductions. So, even if you qualify for a casualty loss deduction, you might not see a tax benefit if you don’t have enough itemized deductions.
The rules described here are for personal property. Keep in mind, the rules for business or income-producing property are different. It’s easier to secure a business property casualty loss deduction. If you’re a victim of a disaster — business or personal — we can help you navigate the complex rules.
Shield your life insurance from federal estate tax
If you have a life insurance policy, be aware that the proceeds your beneficiary receives could be subject to federal estate tax. That is, unless you take steps to ensure that the policy isn’t part of your estate.
What to do
Life insurance proceeds will be included in your taxable estate if:
- Your estate is the beneficiary of the insurance proceeds, or
- You possessed certain economic ownership rights (called “incidents of ownership”) in the policy at your death (or within three years of your death).
The first situation is avoidable simply by making sure your estate isn’t the designated beneficiary of the policy. The second situation is more complicated. If you possess any of the incidents of ownership of the policy, the proceeds will be included in your estate regardless of the beneficiary, even if someone else has legal title to the policy. To avoid that result, you must not retain the right to:
- Change beneficiaries,
- Assign the policy (or revoke an assignment),
- Borrow against the policy’s cash surrender value,
- Pledge the policy as security for a loan, and
- Surrender or cancel the policy.
Note: Merely having any of the above powers will result in the proceeds being included in your estate, even if you never exercise the powers.
To shield life insurance proceeds from estate tax, here are two options:
- Buy-sell agreement. Life insurance may be purchased to fund a buy-sell agreement for a business interest under a “crosspurchase” arrangement. The proceeds won’t be taxed in your estate unless the estate is the beneficiary. Let’s say two business partners agree that the partnership interest of the first to die will be purchased by the survivor. To fund the obligation, each partner buys, pays all premiums for and retains all ownership rights on a policy on the life of the other partner. When the first partner dies, the insurance proceeds aren’t taxed in the estate of the deceased.
- Irrevocable life insurance trust (ILIT). An ILIT can be established and be the owner of a life insurance policy, purchased with assets from the insured. As long as the insured has no rights of ownership in the policy, the proceeds of the policy won’t be taxed to his or her estate.
If you’re considering establishing an ILIT or assigning away rights in a policy you own, we can help. However, unless you live for at least three years after taking these steps, the proceeds will be taxed in your estate. For policies in which you never held incidents of ownership, the three-year rule doesn’t apply. Don’t hesitate to contact us with any questions about your situation.
What do IRS auditors know about your business industry?
Has your business been audited by the IRS? It may be stressful, especially if you don’t know what to expect. It might help to know what information IRS auditors have about your industry. To prepare for an audit, IRS examiners generally research a specific industry, plus issues on a tax return. One tool they often use is the Audit Technique Guide (ATG).
A little-known secret
It’s not widely known, but the public can also access these same guides on the IRS website. In other words, your business can use the guides to gain insight into what the IRS is looking for in terms of compliance with tax laws and regulations.
Many ATGs target specific industries or businesses, such as construction, aerospace, architecture or veterinary medicine. Other ATGs address issues that frequently arise in audits, such as executive compensation, passive activity losses and capitalization of tangible property.
IRS auditors examine many business types, plus individuals and tax-exempt organizations. Each type of return might have unique industry issues, business practices and terminology that auditors need to understand. Using a specific ATG, an auditor may be able to reconcile discrepancies when reported income or expenses aren’t consistent with industry norms, or identify anomalies within the geographic area in which the business is located.
Get a heads-up
Although ATGs were created to help IRS examiners uncover common methods of hiding income and inflating deductions, they also can help businesses ensure they aren’t engaging in practices that could raise audit red flags. Some guides were written several years ago and others are relatively new, or recently revised or updated. Be aware, not every industry has a guide.
You can find a complete list of available ATGs on the IRS website:
April 18 – Last day to file (or extend) your 2021 personal return and pay any tax that is due.
- First quarter 2022 estimated tax payments for individuals, trusts and calendar-year corporations are due (the states of Maine and Massachusetts have an April 19th federal deadline).
- 2021 returns are due for trusts and calendar-year estates and C corporations.
- FinCEN Form 114 (“Report of Foreign Bank and Financial Accounts”) is due — but an automatic extension applies to October 15.
- Any final contribution you plan to make to an IRA or Education Savings Account for 2021 is due.
- SEP and profit-sharing plan contributions are also due today if your return is not being extended.
May 2 – Employers must file Form 941 (“Employer’s Federal Quarterly Tax Return”) for the first quarter (May 10 if all taxes are depos- ited in full and on time). Also, employers must deposit FUTA taxes owed through March if the liability is more than $500.
May 16 – Calendar-year exempt organizations must file (or extend) their 2021 Forms 990, 990-EZ or 990-PF returns.
June 15 – Second quarter 2022 estimated tax payments are due for individuals, calendar-year corporations, estates and trusts.
About Batley CPA
Batley CPA, LLC is a full-service CPA firm providing tax, accounting, payroll and advisory services to businesses and individuals throughout Green Bay and the Fox Cities. Batley CPA regularly provides clients with best practices and strategies to maximize cash flow, profit, reduce taxes, manage costs and risk, and bring meaning to financial and operational data. The company has offices in Appleton, Neenah and Green Bay.