What Business Owners Need to Know About Trust Fund Taxes
When to deposit employment taxes and the penalties for failing to do soBy S.M. Oliva | Reviewed by Canaan Suitt, J.D. | Last updated on January 18, 2024 Featuring practical insights from contributing attorney Stephanie Searles Vogel
Use these links to jump to different sections:
- What Are Trust Fund Taxes?
- How Frequently Do I Have to Make Trust Fund Tax Deposits?
- Failure to Deposit and Trust Fund Recovery Penalties
- Trust Fund Tax Problems Usually Arise When the Company Is in Financial Distress
- Protecting Yourself from Being Held Responsible for a Trust Fund Tax Penalty
- Find an Experienced Tax Lawyer
All small businesses that employ people must understand their obligations to collect and remit federal and state income taxes. When you “pay” employees, you do not actually give them the full amount of their gross wages. Instead, you make certain deductions required by law and then pay the remainder as net wages.
The money you deduct, however, is not yours to keep. It is effectively held “in trust” by you until such time as you pay the funds over to the relevant tax authority. For this reason, the Internal Revenue Service (IRS) and your state’s Department of Revenue (DOR) commonly refer to these deductions as “trust fund taxes.”
What Are Trust Fund Taxes?
Trust fund taxes generally cover the following items:
- The employee’s federal income tax;
- The employee’s mandatory contributions to Social Security and Medicare; and
- The employee’s state income tax.
In the case of state income taxes, an employer must collect trust fund taxes from any resident who works for the company—whether or not they actually perform the work in the state—and any non-resident employee who is paid for services rendered within the state.
How Frequently Do I Have to Make Trust Fund Tax Deposits?
The IRS and DOR each provide the formula for employers to calculate the appropriate trust fund taxes. This is presumably done with the aid of an accountant, but the employer is ultimately responsible for calculating and remitting any taxes collected according to a specified schedule.
Federal Trust Fund Tax Deposits
For federal trust fund taxes, the IRS requires taxpayers to make either monthly or semiweekly deposits. Which schedule applies to your business depends on your total taxable income reported for the four previous quarters, or what is known as the “lookback period.”
Basically, if you reported $50,000 or less in taxes during the lookback period, you are required to deposit trust fund taxes monthly going forward; otherwise, you must make semi-weekly deposits.
State Trust Fund Tax Deposits
State revenue departments operate according to different classification systems. As an example, the Pennsylvania Department of Revenue requires:
- Quarterly deposits of state trust fund taxes if the total amounts withheld are less than $300 per quarter;
- Monthly deposits for taxes withheld up to $999 per quarter;
- Semi-monthly deposits for taxes withheld up to $4,999 per quarter; and
- Semi-weekly deposits for all higher amounts.
Because tax laws vary from one state to another, it’s important to seek professional tax guidance for your specific jurisdiction.
Failure to Deposit and Trust Fund Recovery Penalties
Many employers get themselves into hot water by not remitting their trust fund taxes on time. The reality is that even if you make payments one day late to pay taxes, you are subject to significant penalties. In particular, the IRS will impose the Failure to Deposit (FTD) penalty and the Trust Fund Recovery Penalty (TFRP) against any delinquent business.
The FTD penalties start at 2 percent of any amounts deposited late and rise to as much as 15 percent if trust fund taxes are remitted more than 10 days after the legal due date. And if the business simply doesn’t remit the taxes at all, the trust fund recovery penalty is equal to 100 percent of the unpaid tax.
More importantly, the IRS may seek to collect any unpaid trust fund taxes from anyone considered a “responsible person” for the business. In other words, the IRS can go after the owner, officer, or director of a business individually if there is proof that the person “willfully” failed to collect or remit any trust fund taxes.
Trust Fund Tax Problems Usually Arise When the Company Is in Financial Distress
“Usually, what we see with clients who have trust fund tax issues is that the business is in some kind of financial distress,” says Stephanie Searles Vogel, a tax attorney at Dilworth Paxson in Philadelphia. “Oftentimes, our client will have already been assessed the penalty from the IRS or will have gotten some notices that an assessment is imminent. What we do is essentially argue that they are not a responsible party and therefore cannot be assessed.”
Protecting Yourself from Being Held Responsible for a Trust Fund Tax Penalty
Determining the responsible person(s) is a facts-and-circumstances test, Vogel says.“It has to be someone responsible for collecting and paying the income tax withheld and who also fails to willfully collect or pay them. We’ve had situations where our client is, say, a controller of the corporation but didn’t have any decision-making power about which creditors get paid when and only had the authority to write some checks.”
This process of determining responsibility is a fact-finding endeavor between the attorney and IRS, Searles Vogel says, that requires a lot of paperwork. Thankfully, there is a lot of case law on this issue. That said, it’s not something she recommends tackling on your own. A tax attorney can advise you on the best course of action.
“When an employer is in financial distress, and they’re deciding which creditors should get paid or not, in order for a vendor to come after an employee or officer of the company, they need to pierce the corporate veil,” Searles Vogel adds. “The government doesn’t have to do that for the trust fund taxes. It’s much easier for them to come after an individual. So, if you know the employer is passing along these taxes to the government, you want to make sure they’re doing it in a timely fashion. If they aren’t, you should speak up and say something. Consider taking yourself off check-writing authority or leaving your position, because there’s a good chance the IRS could come after you personally.”
Find an Experienced Tax Lawyer
If you have questions about your company’s trust fund tax responsibilities or are facing tax liabilities, visit the Super Lawyers directory to find an experienced tax lawyer in your area for legal advice. If you want more information on this area of law, see our tax overview.
Additional Tax articles
- What is Tax Law?
- Does My Remote Business Need to Collect Sales and Use Taxes for Other States?
- Am I in Trouble if I Receive an IRS Audit Notice?
- Do I Need a Tax Attorney When I Have an Accountant?
- Do I Have to Report Bartering Income on My Taxes?
- Expats Still Must Pay U.S. Taxes
- What Should You Do When You Get an IRS Audit Notice?
- Should I Get a Tax Lawyer to Handle an IRS Audit?
- How a 529 Plan Can Maximize Savings for College
- What Happens if You Don't Pay Your Taxes?
State Tax articles
Find top lawyers with confidence
The Super Lawyers patented selection process is peer influenced and research driven, selecting the top 5% of attorneys to the Super Lawyers lists each year. We know lawyers and make it easy to connect with them.Find a lawyer near you