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Trust Fund Recovery Penalty: It’s not deductible

Often referred to as the 100 percent penalty, failing to submit payroll taxes comes with personal liability that equals the amount of the unpaid taxes. A taxpayer in a recent case tried to deduct the penalty payment on his personal return.

When does the trust fund recovery penalty become an issue? Why can’t payment of the penalty later be deducted as a business expense on a personal return? We’ll explain in this post.

Who could be on the hook for the penalty?

Payroll taxes are deducted from employee pay and then turned over to a taxing agency. An employer effectively operates as a fiduciary.

When these taxes are not paid, the penalty can be assessed personally against any ‘responsible person’ who:

  • Was in charge of collecting and paying employment taxes
  • And does not collect or pay these taxes

A willful requirement applies, but is broadly interpreted to include anyone who knew or should have known about the tax obligations.

Why can’t you write off a penalty as a business expense on a personal return?

The facts of the recent case involved defunct companies owned by a husband and wife. Their S corporation incurred unpaid payroll taxes. The IRS assessed the trust fund recovery penalty personally against the husband. Some years later, he paid off the penalty from the account of a separate LLC.

That year, the taxpayer tried to deduct the penalty as salary and wages (ordinary business losses). In addition to questions about when salaries were paid, which was years earlier than the penalty, the court found the issue moot because the penalty amount is never a deductible item.

The fine must be paid and it does not qualify for subsequent tax return relief. Avoid these tax consequences by depositing payroll taxes on time.

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