In an earlier post we discussed the so-called “trust fund penalty.” This rule allows the IRS to collect employee payroll tax withholdings directly from any individual who has authority over trust fund taxes but intentionally diverts them from the IRS. The so-called “responsible person,” whether he or she is a business owner or merely an employee, must pay 100% of the diverted employee tax withholdings (so-called “trust fund” withholdings), even if he or she did not personally benefit from the decision.
This situation usually arises when a business is facing a cash crunch. One response is for management to correctly report the amount of trust fund taxes but fail to make an installment payment when due, hoping to catch up before the end of the year. Obviously, this is a bad decision because if the business is unable to catch up on these trust fund withholdings the responsible managers will be left holding the bag.
To minimize this downside, management may be tempted to understate the true amount of trust fund taxes due by diverting some employee compensation to “under the table” cash payments. This approach makes a bad situation far, far worse.
First of all, let’s be clear that knowingly filing false tax returns—such as those which understate employee compensation—is a crime. Don’t do it!
Furthermore, understating the company’s trust fund taxes will not reduce the responsible person’s tax liabilities. He or she will still be responsible for 100% of the actual amount owed.
Finally, in a delicious irony (at least if you are an IRS agent), this approach will ultimately make the company’s financial situation much worse. When tax time comes, the corporation will only be able to deduct employee compensation that was reported as employee compensation. “Under the table” transfers are, by definition, not reportable for tax purposes. This will make the corporation appear much more profitable than it actually was, leading to a vicious downward spiral of mounting tax debt.
No doubt there is a moral to be found somewhere. But that, as they say, is beyond the scope of this discussion.
This is just a basic overview and is not legal advice specific to your situation. If you would like to speak with Jonathan about your situation, please email him at firstname.lastname@example.org or call him at 925-217-3255.
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