Personal Liability

Helping Taxpayers Throughout California

Rex Halverson

A limited liability company (LLC) is a business entity that has attributes of both a corporation and a partnership. When an LLC or corporation is formed, it becomes a legal entity that is separate from its owners. This designation allows the business entity to enter into business contracts, own assets, and be held liable for its own debts.

Employers have an obligation to pay employee wages per their employment contracts. Both Federal and California law require that an employer withhold federal and state payroll taxes or employment taxes from employee wages. The federal withholding tax is comprised of personal income tax withholding according to an employee’s W-4, plus one-half of the social security and Medicare taxes from the employee paychecks. These are also known as “Trust Fund” taxes because the business is supposed to hold these funds in a trust before submitting them to the IRS. The remaining one-half of the employee’s social security and Medicare taxes are regarded as “employer taxes” as they must be contributed by the employer.

If an LLC or corporation fails to pay their payroll taxes, personal liability may fall on the owners or other members of the LLC when these taxes go unpaid. Both Internal Revenue Code section 6672 and California Unemployment Insurance Code section 1735 provide that any individual who is required to collect, truthfully account for, and pay over payroll tax for an LLC or corporation who willfully fails to do so shall be personally liable for the amount due, which may also include penalties and interest.

For federal tax purposes, an LLC may elect to be classified as a partnership or corporation if they are a multimember LLC or as a corporation or disregarded entity if they are a single member LLC. By default, a multimember LLC will be treated as a partnership and a single member LLC will be treated as a disregarded entity. If the LLC has more than one employee or owner, more than one individual can be considered a “responsible person”. Joint and several liability is attached to each party, meaning each responsible person can be held liable for the entire amount.

There are several reasons why a payroll tax may not be paid timely. If a business is short on cash and needs to pay suppliers or other expenses such as rent, they may divert funds from payroll taxes to pay bills. Since the IRS moves slowly, some business owners hope that by the time the IRS comes along they will have enough money to resolve their payroll tax issues. Instead, the payroll tax owed (along with interest and penalties) keeps accruing.

In addition, payroll taxes may not be paid, if an employer misclassifies employees as independent contractors. Payroll tax problems can also occur when dishonest or incompetent employees fail to pay payroll taxes and hide this fact from business owners.

Resolving Payroll Tax Debt with the IRS and/or EDD

Since the IRS or EDD can collect payroll tax debt related to LLCs and corporations from the business owners, officers, employees or independent contractors that qualify as a “responsible person”, any such person needs to be vigilant and look out for him- or herself. Do yourself a favor and start by consulting a tax attorney or tax professional that handles payroll or employment taxes. A tax attorney or tax professional can help you with payroll tax problems by providing real solutions that may include:

  • Acquiring a short-term deferment of payroll tax debt;
  • Negotiating an installment payment agreement with the IRS and/or EDD so that your payroll tax debt can be paid over a period of years;
  • Submitting an Offer in Compromise to reduce the amount of payroll tax owed;
  • Conducting a review of payroll tax accounts to assess whether the IRS and/or EDD calculated your payroll taxes correctly;
  • Determining if the statute of limitations for collecting your payroll tax debt has expired or will soon expire;
  • Negotiating a release of a tax lien so that you can get a loan from your bank to pay off the taxes;
  • Negotiating a release of a tax levy of your bank accounts containing funds that are needed for other business obligations like payroll;
  • Figuring out if your payroll tax debt is uncollectible; or,
  • Filing claims for an abatement of interest and penalties.

Trust fund taxes are not dischargeable in Chapter 7 Bankruptcy filings, no matter how long ago the taxes were assessed.

Penalties for Unpaid Payroll Taxes

The IRS will send Form 2841, Notice to Make Special Deposits of Taxes to a company if they do not pay their proper payroll taxes. This notice requires future payroll tax withholdings to be deposited into a separate trust account for the government, and the deposits must be made within two days of being withheld from the employees. An LLC or corporation that does not strictly adhere to this notice may be criminally prosecuted.

Failure to pay any payroll taxes that are owed after this notice is received can lead to jail time of up to one year and a fine of up to $5,000, for each such failure.

Certain defenses can be used to avoid prosecution. For example, if an individual did not comply due to circumstances out of their control, such as the total destruction of the business, theft of money, a burglary of the business, or a bank failure before a tax deposit is due. But, please note that these defenses are not common and can be difficult to fall within.

An Experienced Payroll / Employment Tax Attorney or Tax Professional Can Help

Don’t try to handle a payroll tax audit alone or go to a Trust Fund Recovery Penalty interview at the IRS without a professional at your side!  An experienced payroll tax attorney or tax professional can assist you in so many ways. For instance, we can negotiate a settlement, offer in compromise or installment agreement with the IRS or EDD and appeal your tax matter up the chain of command at these agencies. More importantly, our team may be able to prevent the IRS or EDD from holding you personally responsible for these debts.

At Rex Halverson & Associates, we have over 40 years of experience helping business owners with payroll tax issues. We can determine if you are liable for the trust fund recovery penalty (TFRP). If it is determined that you are not a responsible party, we can negotiate with the IRS or EDD in an effort to abate the TFRP. If you need any assistance with a payroll or employment tax issue, contact us at (916) 444-0015 for a fee initial consultation.