If you own or manage a business with employees, there’s a harsh tax penalty that you could be at risk for paying personally. The Trust Fund Recovery Penalty (TFRP) applies to Social Security and income taxes that are withheld by a business from its employees’ wages.

The Sweeping Penalty: Exploring the Broad Impact of the Trust Fund Recovery Penalty

The TFRP is dangerous because it applies to a broad range of actions and to a wide range of people involved in a business.

Here are some answers to questions about the penalty:

What Actions Are Penalized? Unveiling the Consequences of Trust Fund Recovery Penalty

The TFRP applies to any willful failure to collect, or truthfully account for, and pay over taxes required to be withheld from employees’ wages.

Why Is It So Harsh? Delving into the Severity of the Trust Fund Recovery Penalty

Taxes are considered the government’s property. The IRS explains that Social Security and income taxes “are called trust fund taxes because you actually hold the employee’s money in trust until you make a federal tax deposit in that amount.”

The penalty is sometimes called the “100% penalty” because the person found liable is personally penalized 100% of the taxes due. The amounts the IRS seeks are usually substantial and the IRS is aggressive in enforcing the penalty.

Who’s at Risk: Assessing the Individuals Vulnerable to the Trust Fund Recovery Penalty

The penalty can be imposed on anyone “responsible” for collecting and paying tax. This has been broadly defined to include a corporation’s officers, directors and shareholders, a partnership’s partners and any employee with related duties. In some circumstances, voluntary board members of tax-exempt organizations have been subject to this penalty. In other cases, responsibility has been extended to professional advisors and family members close to the business.

According to the IRS, responsibility is a matter of status, duty and authority. Anyone with the power to see that taxes are (or aren’t) paid may be responsible. There’s often more than one responsible person in a business, but each is at risk for the entire penalty. You may not be directly involved with the payroll tax withholding process in your business. But if you learn of a failure to pay withheld taxes and have the power to pay them, you become a responsible person. Although taxpayers held liable can sue other responsible people for contribution, this action must be taken entirely on their own after the TFRP is paid.

What’s Considered Willful? Decoding the Definition of Willfulness in the Trust Fund Recovery Penalty

There doesn’t have to be an overt intent to evade taxes. Simply paying bills or obtaining supplies instead of paying over-withheld taxes is willful behavior. And just because you delegate responsibilities to someone else doesn’t necessarily mean you’re off the hook. Failing to do the job yourself can be treated as willful.

Recent Cases: Real-life Examples Highlighting the Implications of the Trust Fund Recovery Penalty

Here are two cases that illustrate the risks.

1. A U.S. Appeals Court held a hospital administrator liable for the TFRP. The administrator was responsible for payroll, as well as signing and reviewing checks. She also knew that the financially troubled hospital wasn’t paying withheld taxes to the IRS. Instead of prioritizing paying taxes, she paid vendors and employees’ wages. (Cashaw, CA 5, 5/31/23)
2. A corporation owner’s daughter/corporate officer was assessed a $680,472 TFRP for unpaid payroll taxes. She argued that she wasn’t a responsible party. She owned no stock and couldn’t hire and fire employees. But she did have the power to write checks and pay vendors and was aware of the unpaid taxes. A U.S. Appeals Court found the “great weight of evidence” indicated she was a responsible party and the TFRP was upheld. (Scott, CA 11, 10/31/22)

Best Advice: Protecting Your Business from the Trust Fund Recovery Penalty - Key Steps to Follow

Under no circumstances should you “borrow” from withheld amounts. All funds withheld should be paid over to the government on time. Contact us with any questions.

The U.S. Department of Labor (DOL) recently announced that a jury in a landmark case, Walsh v. East Penn Manufacturing Co, Inc., DC-PA, has awarded more than $22 million in back wages to about 7,500 employees of a battery manufacturer. The award marks the largest recorded verdict ever under the Fair Labor Standards Act (FLSA). Further, the DOL, which brought the lawsuit, plans to request an equal amount in liquidated damages and an injunction requiring future FLSA compliance by the manufacturer.

The jury found that the manufacturer was required to pay affected workers for all of their working time — including the actual additional time needed to put on and remove protective equipment and to shower to avoid the dangers of lead exposure and other hazards — resulting in overtime violations. This case should act as a wakeup call for all manufacturers to pay close attention to FLSA rules and regulations concerning tracking time and pay.

FLSA Pay Regulations: What You Need to Know

Under the FLSA, employees must be paid an overtime rate of one and a half times their regular pay rate for time worked above 40 hours a week, unless specific exemptions exist. FLSA exemptions exclude certain executives, administrative and professional (EAP) employees; outside salespeople; and computer employees from the federal overtime rules.

What constitutes hours worked under the FLSA? “Workday,” in general, means the period between the time on any particular day when employees commence their “principal activities” and the time at which they cease such activities. Principal activities are those that employees are employed to perform, such as the work manufacturing employees perform during their shift on the manufacturing floor — and those hours must be compensated.

But employees must also be compensated for all activities that are essential to performing their principal activities, even if the activities are performed before employees begin, or after they end, their principal work activities. The workday may, therefore, be longer than employees’ scheduled shift, hours, tour of duty, or production line time.

For example, if employees in a chemical plant cannot perform their principal activities without putting on certain clothes, then changing clothes on the employer’s premises at the beginning and end of the workday would be essential to performing their principal activities. The time spent changing clothes would be part of the workday and must be compensated.

Key Details of the Landmark Walsh v. East Penn Manufacturing Co, Inc. Case

The manufacturer, one of the largest battery producers in the world, maintained two sets of time records for its employees. The first was based on a card-scanning system requiring employees to swipe in no more than 14 minutes before a shift and no more than 14 minutes after a shift. The other set of “adjusted” records didn’t reflect the 14-minute rule before and after shifts.

The manufacturer paid its employees based on the adjusted time records, without taking the 14-minute rule into account, even though it was aware that more time was needed for pre- and post-shift activities. In response to an employee’s complaint, the employer adjusted its policy, providing a five-minute grace period before a shift to change into uniforms and additional time for cleaning up after a shift when approved by a manager. Also, the employer granted employees 10 minutes for shower time after their shifts.

The parties didn’t dispute that the activities before and after employees’ 8-hour shifts were “integral and indispensable.” However, they disagreed about the measuring stick used for this compensable time.

The key difference between the parties: The DOL argued that the employer should record the actual time it takes for workers to put on and take off their protective uniforms. Conversely, the employer asserted that it’s required to pay employees only for the “reasonable time” to complete those tasks and that the 15 minutes for pre-shift activity and 10 minutes for post-shift activity is sufficient.

In the end, the manufacturer couldn’t persuade the court. The court confirmed that the appropriate method for measuring compensable time is based on the continuous workday rule, whereby employees are compensated for all time spent during the continuous workday. The court saw no binding legal precedence for using a “reasonable” amount of time.

Moreover, the court indicated that the “reasonable” time standard was used only for calculating back-pay damages and not for regular pay. So, it agreed with the DOL’s position that compensation should be based on the actual time spent on the activities — not a “reasonable” amount of time.

Besides siding with the employees on overtime pay, the court found that the manufacturer violated FLSA recordkeeping provisions. Reason: The manufacturer openly admitted it didn’t record the actual time spent on pre- and post-shift activities.

Avoid Costly Errors: Lessons Learned from Others' Business Mistakes

This case is a cautionary tale for manufacturing companies in similar circumstances. Be sure to accurately track work hours of employees according to the FLSA and other prevailing laws and regulations — and to pay them for the tracked time.

Despite the robust job market, some people are still losing their jobs. If you’re laid off or terminated from employment, taxes are probably the last thing on your mind. However, you may face tax implications due to your changed personal and professional circumstances. Depending on your situation, these can be complex and require you to make decisions that may affect your tax picture — both this year and in the future.

Navigating Tax Implications of Unemployment and Severance Pay

Unemployment compensation is taxable for federal tax purposes, as are payments for any accumulated vacation or sick time. Although severance pay is also taxable and subject to federal income tax withholding, some elements of a severance package may be specially treated. For example:

• If you sell stock acquired by way of an incentive stock option, part or all of your gain may be taxed at lower long-term capital gains rates rather than at ordinary income tax rates, depending on whether you meet a special dual holding period.
• If you received — or will receive — what’s commonly referred to as a golden parachute payment, you may be subject to an excise tax equal to 20% of the portion of the payment that’s treated as an “excess parachute payment” under complex rules. In addition, the excess parachute payment also is subject to ordinary income tax.
• The value of job placement assistance you receive from your former employer usually is tax-free. However, the assistance is taxable if you had a choice between receiving cash or outplacement help.

Understanding Tax Considerations for Health Insurance After Job Loss

Also, be aware that under the COBRA rules, employers that offer group health coverage typically must provide continuation coverage to most terminated employees and their families. While the cost of COBRA coverage may be expensive, the cost of any premium you pay for insurance that covers medical care is a medical expense, which is deductible if you itemize deductions and if your total medical expenses exceed 7.5% of your adjusted gross income.

If your ex-employer pays for some of your medical coverage for a period of time following termination, you won't be taxed on the value of this benefit.

Managing Retirement Plans: Tax Strategies for Termination

Employees whose employment is terminated may also need tax planning help to determine the best option for amounts they’ve accumulated in retirement plans sponsored by their former employers. For most employees, a tax-free rollover to an IRA is the best move, if the terms of the plan allow a pre-retirement payout.

If the distribution from the retirement plan includes employer securities in a lump sum, the distribution is taxed under the lump-sum rules except that “net unrealized appreciation” in the value of the stock isn’t taxed until the securities are sold or otherwise disposed of in a later transaction. If you’re under the age of 59½ and must make withdrawals from your company plan or IRA to supplement your income, there may be an additional 10% penalty tax, unless you qualify for an exception.

Further, any loans you’ve taken out from your employer’s retirement plan, such as a 401(k) plan loan, may be required to be repaid immediately, or within a specified period. If such a loan isn’t repaid, it may be treated as if the loan is in default. If the balance of the loan isn’t repaid within the required period, it typically will be treated as a taxable deemed distribution.

Contact us so that we can chart the best tax course for you during this transition period.

Family businesses make up a huge percentage of companies in the United States and produce much of the country’s gross domestic product. Often defined as companies that are majority owned by a single family with two or more members involved in their management, family businesses can be a significant source of wealth.

However, for various reasons, they may also potentially face higher fraud risks. Here’s why, and how you can reduce those risks.

Overcoming Obstacles in Fraud Prevention for Family Businesses

Why might family businesses be more vulnerable to fraud than other companies? For one thing, prevention efforts can be hampered by loyalty and affection. One of the biggest obstacles to fraud prevention is simply acknowledging that someone in the family could be capable of initiating or overlooking unethical or illegal activities.

But like any other business, family enterprises should include a system of internal controls that make fraud difficult to perpetrate. It may be awkward to exercise authority over members of one’s own family, but someone needs to take charge if or when issues arise. Sometimes family businesses need to hit the reset button and reestablish a hierarchy and process of authority while moving forward with the enterprise.

The Power of Independent Advice in Mitigating Fraud Risks for Family Businesses

Of course, the person in charge potentially could be the one defrauding the company. That’s why independent auditors and legal advisors are critical. Your family business should look outside its immediate circles of relatives and friends and retain professional advisors who can be objective when assessing the company. Audited financial statements from independent accountants protect the business and its stakeholders.

If your company is large enough to have a board of directors, it should include at least one outsider who’s strong enough to tell you things you may not want to hear. In some extreme cases, members of all-family boards have been known to work together to bilk their companies. This becomes much more difficult when collusion requires the assistance of an outsider.

Dealing with Fraud: Holding Perpetrators Accountable in Family Businesses

Another factor that makes preventing fraud in family businesses hard is how they tend to handle fraud incidents. Even when legal action is an option, families rarely can bring themselves to pursue action against one of their own. Sometimes families choose to save the fraudster from public scandal or punishment rather than maintain ethical professional standards. Many fraud perpetrators know that.

If you discover a family member is committing fraud, consult with a trusted attorney or accountant. An advisor may want to explain to the perpetrator the illegality and possible consequences of the fraudulent actions. If such interventions don’t work, however, you and other family members may have no choice but to seek prosecution.

Avoiding Pitfalls: The Importance of Trust with Caution in Family Business Relationships

There are plenty of advantages to working with family members, but you also need to watch for pitfalls. To maintain high ethical standards and prevent fraud, rely on professional advisors and nonfamily officers to provide perspective and objective advice. Contact us for help with internal controls.

Maximize Your Business Travel Deductions This Summer

Discover essential rules to maximize business travel deductions. Learn deducting expenses like flights, meals, lodging, and more. Optimize your small business deductions and unlock substantial tax savings. 

Exploring the Pros and Cons of First-Year Real Estate Depreciation Deductions

Explore the pros and cons of first-year real estate depreciation deductions! Discover how your business can claim significant tax savings for eligible expenditures. Navigate the potential of Qualified Improvement Property (QIP) depreciation and maximize your deductions. Learn about limitations, bonus depreciation, and strategic considerations. Make informed decisions for optimal tax planning. 

Finding Stability and Returns: Exploring the Benefits of Bonds

This article covers the benefits of bonds for stability and returns! Explore U.S. government savings bonds, Treasury bills, Treasury notes, tax-exempt municipal bonds, and corporate bonds. Gain stability with government bonds and potential tax advantages. Consider higher yields with corporate bonds but be aware of market fluctuations and tax implications. Make informed investment decisions for financial growth.