He thought he had done the right thing. A business owner wrote a Revenue Officer a $50,000 check towards his company's payroll tax debt. He had the money, sent it to the person assigned to his case, and expected his exposure to shrink by $50,000.
It didn't, and when he found out why, he was furious.
His CPA referred the case to me after the check had already gone out. The CPA had taken good care of this client for years, but he had no idea what happened was even possible, and he admitted he didn't know much about the Trust Fund Recovery Penalty.
That isn't a knock on him. Nothing in a CPA's normal work forces anyone to learn how payroll collections operate until a client is in the middle of it, and the IRS isn't going to explain the rules.
Here are four things your clients with payroll tax debt need someone around them to know:
Part of a payroll tax debt can become the owner's personal debt.
Only that part follows the owner personally, and the IRS decides how a payment is applied unless someone tells it otherwise.
Telling it otherwise takes one sentence.
Once a payment is applied, it stays where the IRS put it.
1. Part of a Payroll Tax Debt Can Become the Owner's Personal Debt
In payroll cases, a Revenue Officer is almost always assigned. One of the RO's jobs is deciding who should be held personally responsible for part of the debt through the Trust Fund Recovery Penalty.
The RO assesses it against a "responsible person," someone with the authority to decide which bills got paid and who chose not to pay the IRS. In a small or mid-size business, that is usually the owner.
The penalty reaches only the trust fund portion of the payroll tax: the income tax withheld from employees' paychecks plus the employees' share of Social Security and Medicare.
That is money the business took out of its employees' pay and was supposed to hold for the government; i.e., the company stole funds, which is why the law lets the IRS go after the people behind the business.
Once the IRS assesses the TFRP, it becomes the owner's personal debt. It follows him even if the business closes, and the IRS can collect it from his bank accounts, his wages, and his property.
2. Only the Trust Fund Portion Follows the Owner, and the IRS Decides Where a Payment Is Applied
A payroll balance has two parts. The trust fund portion can become the owner's personal debt, while the rest, the employer's share of Social Security and Medicare plus penalties and interest, stays with the business.
When a business sends a payment without saying where it should go, the IRS applies it the way that best serves the government.
That means applying the payment to both the trust fund portion and the business portion, reducing only the portion the business owes, while the portion that follows the owner stays where it was.
That's what happened to my client.
Here is a hypothetical to show how much that can matter.
Say a business owes $120,000 in payroll taxes, with $70,000 in trust fund and $50,000 in the employer's share, penalties, and interest. The owner sends a $50,000 check with no instructions, and the IRS applies it to the full payroll balance and only $40,000 goes to the trust fund portion. The business now owes $70,000, and the owner's potential personal liability is $30,000.
Now the same owner sends the same check with a written instruction to apply it to the trust fund portion. The business still owes $70,000, but the owner's potential personal liability drops to $20,000.
It is the same check sent to the same Revenue Officer, and the difference to the owner is $10,000 of pesonal debt.
3. Telling the IRS Where the Payment Goes Takes One Sentence
This is the part that made my client angriest, because the fix is so small.
A business making a voluntary payment on a payroll balance can designate where it goes, and no special form is needed. The check goes to the Revenue Officer with a plain written instruction to apply it only to the trust fund portion of the payroll debt.
Something like this does the job: "This voluntary payment of $50,000 is to be applied only to the trust fund portion of [business name]'s payroll tax liability for [tax periods]."
My client's first question was the one every owner asks: why didn't the Revenue Officer just tell him?
It isn't the RO's job. The RO is there to collect, and nothing requires the IRS to point a taxpayer toward the way of paying that helps him most and the government least.
The only people who could have told him were the people around him, and none of them knew.
4. Once a Payment Is Applied, It Stays Where the IRS Put It
By the time I got involved, it was too late. The payment came first, and the referral came afterward; by then, the $50,000 had been applied, with no way to redirect it.
This type of mistake happens when the owner sends money in to show good faith, when a bookkeeper is told to "just get something to the IRS," or when a payment goes out to keep the Revenue Officer happy.
Designation is only one of the many pertinent rules in a payroll case.
The answers given in the Form 4180 interview shape who ends up owing personally, and they are hard to take back. After Letter 1153 proposes the personal assessment, you have 60 days to dispute it. The business and personal resolutions must be worked out at the same time, because a plan for one doesn't protect the other.
Payroll cases are full of moments where a decision made without knowing the rule can't be undone. The $50,000 check is the easiest one to fix.
TL;DR
⏩ An owner sent a Revenue Officer $50,000 on his company's payroll tax debt, and only part of it reduced what he could owe personally.
⏩ The Trust Fund Recovery Penalty makes the owner personally liable for the trust fund portion, while the employer's share, penalties, and interest stay with the business.
⏩ A payment sent without instructions is applied in the way that serves the government.
⏩ One written sentence sent with the check designates a voluntary payment to the trust fund portion.
⏩ Once a payment is applied, it can't be redirected, and the IRS will never suggest designating it.
⏩ Designation is one of several payroll rules where a decision made without knowing it can't be undone.
BTW, I get the same three questions from CPAs and attorneys every time they have a client with tax debt. I finally wrote the answers down.
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