07.20.2011 IRS Expands Trust Fund Recovery Penalty Assessments to Third Party Payroll Providers

The Internal Revenue Service (“IRS”) has determined that the trust fund recovery penalty (“TFRP”) that is imposed for failure to remit payroll taxes to the IRS may be imposed against third party payroll providers in some circumstances.

On July 1, 2011, the IRS’ Small Business/Self-Employed Division issued an internal memorandum in which it concluded that expansion of the scope of responsible parties to include third-party payroll service providers and professional employer organizations was justified under existing law.

Employers are required to withhold income and Federal Insurance Contributions Act (“FICA”) taxes from their employees’ wages and must pay the employer’s share of FICA taxes and Federal Unemployment Tax Act (“FUTA”) taxes.[1]  Failure to remit these employment taxes subjects the employer to substantial civil penalties and possible criminal sanctions.[2]  In addition, officers, directors and employees of the employer may be jointly and severally liable for the TFRP, which generally equals 100% of the unpaid tax, if the officer, director or employee has a duty to ensure that those taxes are paid.[3]

In many cases, employers contract with payroll firms to provide some or all of the employer’s employment tax withholding, reporting and payment responsibilities.  However, if a payroll firm fails to pay appropriate employment taxes, the employer, including any responsible parties in the organization, remain liable for the unpaid taxes.[4]

In 2004, the National Taxpayer Advocate (“NTA”) urged Congress to hold payroll firms responsible for their willful failures to pay employment taxes.[5]  The NTA cited several highly publicized cases in which employers had paid employment taxes to payroll firms, but the firms never remitted the funds to the IRS.  As the employers remained liable to the IRS, the employers were left to pay double their employment taxes – once to the payroll firm and once to the IRS.

The IRS memorandum follows the recommendation of the NTA and instructs revenue officers to impose the TFRP on payroll firms, including officers, directors, and employees of payroll firms, if the firms have control over the payment of the employment taxes and the failure to pay the taxes was “willful.” The memorandum also makes clear that the new liability for payroll firms does not relieve the employer’s joint and several liability for the TFRP.

The shift to liability for payroll firms adds a new component to employment tax disputes.  On the one hand, the payroll firms’ liability for the TFRP increases the number of persons and assets available to pay the taxes, which reduces the likelihood that the employer’s assets will be used.  On the other hand, payroll firms must institute appropriate safeguards to adjust to this new source of potential liability not only for the firm, but also for its owners, officers and directors.   

[1] IRC Code §§ 3102(a), 3111, 3402(a) and 6302.

[2] Id. § 6672.

[3] Id. § 6671(b).

[4] See, e.g., Pediatric Affiliates v. U.S., 99 AFTR 2d 2007-2240 (3rd Cir. 2007).

[5] National Taxpayer Advocate, 2004 Annual Report to Congress, 395-400.

For more information about this topic, please contact the authors or any member of the Williams Mullen Tax Law Team.

Please note:
This newsletter contains general, condensed summaries of actual legal matters, statutes and opinions for information purposes. It is not meant to be and should not be construed as legal advice. Readers with particular needs on specific issues should retain the services of competent counsel. For more information, please visit our website at or contact Farhad Aghdami, 804.420.6440 or For mailing list inquiries or to be removed from this mailing list, please contact Julie Layne at or 804.420.6311.