If you have employees, you are undoubtedly familiar with payroll taxes: the income taxes and Social Security and Medicare (FICA) taxes that you must withhold from each paycheck issued to an employee. These taxes are often referred to as “trust fund” taxes because the employer is required to hold them in trust for the federal government and pay them over to the IRS. (Employers must also pay their portion of FICA taxes for each employee.)
If the employer experiences a cash crunch, the trust fund money might start to look like a tempting source for a loan. But don't do it! There are significant penalties for employers who divert trust fund money.
If you have control over the trust fund taxes and choose to divert them away from the IRS, you will be liable for the entire amount. This is true even if you are merely an employee who receives no financial benefit from diverting the trust fund taxes. Under the “100% penalty,” anyone with authority over trust fund taxes who willfully (intentionally) diverts them from the IRS will be liable for the entire amount that he or she diverted.
How the Penalty Works
Here is an example to illustrate what could happen to an employer who diverts trust fund money. ABC Corp. distributes parts in the auto industry. When a customer falls behind on its payments, ABC Corp. is not able to pay its supplier on time. The supplier refuses to ship more parts until ABC Corp. pays up. ABC Corp. has no cash and no line of credit. With no access to product, it is dead in the water.
Janice, the CFO, notices that ABC Corp. has accumulated $10,000 in trust fund taxes which are not due yet. Janice is not a shareholder of ABC Corp., but she is a dedicated and creative employee. To keep the company alive, she uses this money to pay the supplier and purchase more parts. Janice fully intends to replenish the trust fund account at the earliest opportunity. But in spite of her efforts, ABC Corp. goes bankrupt and is not able to repay the $10,000.
What happens next? Besides losing her job, Janice will be liable for the entire $10,000 she raided from the trust fund account to the pay the supplier. The fact that Janice intended to put the money back does not matter. Neither does the fact that she is merely an employee of the company who did not benefit financially from the diversion. Because she had authority over the trust fund taxes and chose to divert them to the supplier, she is liable for the entire amount that she diverted.
The moral of the story? Trust fund taxes belong to the IRS, not to your company. Although they may temporarily sit in an accessible bank account, you are merely the trustee who withholds this money from employees and hands it over to the IRS.