The trust fund recovery penalty can cause financial havoc for anyone involved in a business that did not pay over its employee withholdings to the IRS. Internal Revenue Code Section 6672 allows the IRS to investigate those in the business who were part of the decision not to pay the IRS and hold them personally responsible for repayment.
The amount of the trust fund recovery penalty charged to the individuals is equal to the taxes deducted from employee paychecks but not paid to the IRS.
Usually, the trust fund recovery penalty involves defending on the basis of liability – developing facts to indicate you had no control over company finances.
But even if you had control, an inability to personally repay the taxes can be a procedural defense to the trust fund recovery penalty. The investigating IRS Revenue Officer has discretion not to hold you responsible if it can be proven that you are – and will continue to be – uncollectible.
Uncollectible is defined by the IRS as being financially unable to pay – doing so would create a hardship for you and your family, leaving you unable to pay for basic necessities. Uncollectible status also requires that your assets be of minimal value to the IRS.
The basis for using collectibility, not liability, as a method of defense in trust fund investigations can be found in the Internal Revenue Manual Sections 18.104.22.168(2) and 22.214.171.124.1.
The IRS will consider many factors in determining whether they should withhold assessment of the trust fund recovery penalty based on financial hardship. Factors include whether you have had IRS troubles in the past, your age, occupation, family size, amount of income tax refunds, future earning potential and the probability of an increase in the value of your assets.
The future ability to pay should not be overlooked as a defense to the trust fund recovery penalty. It is important to recognize the right situation where personal financial disclosure during the IRS investigation could make a difference to the defense. If there will be problems paying the trust fund taxes later, considering asking the IRS to eliminate the problem early.