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Trust Fund Recovery Penalty: Why Payroll Tax Money Is Never Working Capital

Writer: Tetiana Voita
Tetiana Voita
Oct 5
8 min read
Payroll tax debt can become personal: payroll documents marked unpaid beside a model home and keys, illustrating business owners’ personal liability.

When cash runs short, every business owner ends up ranking bills: payroll, rent, the supplier threatening to stop deliveries, the IRS. A Tax Court decision issued on September 28, 2026, shows why one of those bills is different from the rest. Under the trust fund recovery penalty, the payroll taxes your company withheld from employees can become your personal debt, and keeping your crew paid is not a defense. Here is what happened in the case, who the rule reaches, and how to structure your cash so you never face that choice.


What Happened in Amodio v. Commissioner

Thomas Amodio, a former carpenter, founded Creative Solutions, Inc. in 2002. It was a union construction shop installing retail display cases and millwork in the New York/New Jersey area. In 2015 and 2016, a major client paid slowly while union wages and benefits kept coming due.

The decision to stop sending employment taxes to the IRS was not his. His office manager and the company's outside payroll provider made it, and he learned about it afterward. What he did next is what made him liable: he kept the company operating and used incoming money for employees' net wages and union benefit contributions, not the overdue taxes.

The IRS assessed the penalty against him personally. After the company settled its own employment tax debt through an offer in compromise in 2020, the IRS still moved to levy against him, and he challenged it in Tax Court (docket 9959-22L). The court decided two questions:

  • Was his failure willful? Yes. The court accepted that the pressure was real: if wages or benefits had been missed, the unions would have pulled their members off his jobsites. It still treated wages owed to employees as one more creditor competing with the IRS.

  • Did the company's offer in compromise limit what the IRS could take from him? In this case, yes. The court treated his penalty and the company's liability as one debt that can be collected only once. The IRS could collect from him no more than the company still owed for each quarter after the offer.

Two caveats matter. Amodio is a memorandum opinion by a Special Trial Judge, so it does not bind future cases. The court also left room for the IRS to collect more when it gives a specific reason, and the Internal Revenue Manual takes the position that a responsible person can still be pursued for trust fund taxes a company compromise leaves unpaid. Treat the offer-in-compromise ruling as a useful argument, not a guarantee.


What the Trust Fund Recovery Penalty Actually Covers

When you run payroll, part of each paycheck never belongs to your business. The federal income tax you withhold and the employees' share of Social Security and Medicare are held in trust for the government until you deposit them. That is why the IRS calls them trust fund taxes.

The trust fund recovery penalty, imposed under Internal Revenue Code Section 6672, equals the unpaid balance of those taxes. It is figured from:

  • federal income tax withheld from employees and not paid over, plus

  • the employees' share of Social Security and Medicare tax.

Your company's matching share is not part of the personal penalty. The business still owes it, along with failure-to-deposit penalties and interest. And the IRS does not wait for the business to close: it can assess the penalty while the company is still operating.

Who counts as a "responsible person"

Ownership alone is not the test. The IRS looks at who had the duty and the power to direct the collection, accounting, and payment of these taxes. That can include corporate officers and employees, partnership members, directors, shareholders, anyone with authority over which bills get paid, and even payroll service providers and PEOs. An employee who only paid bills as a supervisor directed is generally not responsible.

Forming an LLC or a corporation does not change this. The penalty is personal by design.

What "willful" means

Willfulness does not require bad intent. Under the IRS standard, you knew or should have known about the unpaid taxes, and you either intentionally disregarded the law or were plainly indifferent to it. The IRS also says that paying other creditors with available funds while employment taxes go unpaid is an indication of willfulness. That is exactly the pattern in Amodio.


The Real Lesson: Payroll Tax Money Is Never Working Capital

The most dangerous cash-flow mistake a business can make is using IRS money as working capital. Most payroll tax problems don't start with fraud. They start with a cash gap and a bank balance that looks bigger than it is.

"When a business runs short on cash, owners start choosing: payroll, rent, a supplier, or the IRS. I always tell business owners not to look at the whole bank balance as their money. You can have a hundred thousand dollars in the account, but part of it already belongs to the IRS, part to payroll, part to sales tax. Cash balance and free cash are not the same thing." — Tetiana Voita, founder of TaxesZenPro

Here is what that looks like in a hypothetical small-business account:

Item

Amount

Bank balance

$100,000

Withheld income tax and employee FICA, not yet deposited

–$14,000

Employer share of Social Security and Medicare

–$4,600

Sales tax collected from customers, due this month

–$9,400

Next net payroll

–$38,000

Rent and insurance due within 10 days

–$12,000

Free cash

$22,000

The owner who sees $100,000 is really deciding with $22,000. And the gap compounds fast. Picture a company with $60,000 of gross biweekly payroll, about $7,000 of withheld income tax and $4,590 of employee Social Security and Medicare per pay period. Skip six deposits and roughly $69,500 of trust fund taxes has built up, the amount that could become personal. The company also owes its matching share, plus a failure-to-deposit penalty that reaches 10% once a deposit is more than 15 days late and 15% if it is still unpaid more than 10 days after the first IRS notice.

Three CFO-level habits prevent this:

  1. Separate the money on payday. Move withheld taxes and the employer share into a dedicated tax account the same day you fund net pay.

  2. Forecast cash at least 13 weeks out, with payroll taxes as fixed outflows, never as flexible ones.

  3. Reconcile weekly, so a missed deposit shows up in days, not quarters. Your IRS business tax account shows which payments actually posted.

If your books can't show tax liabilities separately from operating cash today, our monthly bookkeeping and financial control service is built to fix exactly that.


What to Do the Moment You Learn Deposits Were Missed

Amodio's liability came from decisions he made after he found out. The window between discovery and the IRS's first call is where an owner has the most control.

  1. Stop adding to the balance. Every new payroll creates new trust fund taxes. Fund current deposits before discretionary spending. If you can't cover wages and taxes together, the payroll itself may need to shrink.

  2. Get the real numbers. Pull your Forms 941 and deposit records and see which quarters and amounts are open. If you use a payroll provider, verify what it actually deposited. Outsourcing doesn't move the duty: IRS Publication 15 says the employer stays responsible if the third party fails.

  3. Designate voluntary payments in writing. IRS Chief Counsel advice explains that a voluntary payment can be directed to the trust fund portion if the designation is specific, written, and made at the time of payment. Without it, the IRS generally applies the payment to non-trust fund taxes first. Chief Counsel advice is not precedent, so have a professional prepare the designation.

  4. Explore a payment arrangement early. Options are easier to negotiate before collection escalates. See our guide to adding new tax debt to an existing IRS payment plan.

  5. Take the proposal letter seriously. Before assessing the penalty, the IRS sends a letter proposing it. You generally have 60 days (75 if the letter is addressed to you outside the U.S.) to appeal, as explained in Publication 5. After assessment, the IRS can file a lien or levy personal assets. Get qualified representation (an attorney, CPA, or enrolled agent) before any IRS interview. If a notice is already on your desk, tell us what you received and we can help you rebuild the quarter-by-quarter deposit history your representative will need.

  6. Coordinate business and personal resolutions. If your company is negotiating an offer in compromise, address every responsible person's exposure at the same time and document how the offer applies to each quarter. Part of the reason Amodio ended in a recomputation is that the record didn't show this clearly.


Common Mistakes That Turn a Business Debt Into a Personal One

  • "Our payroll company handles it." In Amodio, the payroll provider was part of the problem. Verify deposits yourself.

  • "Employees have to be paid first." Understandable, but courts treat wages owed as one more creditor.

  • "My LLC protects me." Entity choice does not limit the trust fund recovery penalty.

  • "We're still open, so the IRS will wait." The IRS can assess the penalty while the business keeps operating.

  • Sending undesignated catch-up payments, which may go to non-trust fund taxes first and leave your personal exposure untouched.

  • Counting on Amodio. A nonbinding memorandum opinion is an argument for your representative, not a plan.


Frequently Asked Questions

Is the trust fund recovery penalty the same as my company's payroll tax bill? 

No. It covers only the trust fund portion: withheld federal income tax plus the employees' share of Social Security and Medicare. The employer's matching share, the company's penalties, and interest stay with the business.

Can more than one person be held liable? 

Yes. The IRS can assess several responsible persons for the same unpaid taxes. Under Section 6672(d), a person who pays more than their proportionate share can recover the excess from the others.

My bookkeeper stopped making deposits without telling me. Am I already liable? 

Not automatically. Responsibility and willfulness depend on the facts. But Amodio shows that once you know, the way you use company money next matters a great deal. Act quickly and document what you did.

Does an accepted offer in compromise for my company erase my personal penalty? 

It may limit it. In Amodio, the court capped collection at the company's remaining liability for each quarter. The opinion is nonbinding, the IRS manual takes a different view, and the result depends on your facts.

Does this apply to state payroll and sales taxes? 

This article covers the federal penalty. States set their own rules for state income tax withholding and sales tax collected from customers, and some also hold individuals responsible. Check with your state tax agency or a tax professional.


Keep the IRS's Money Out of Your Operating Budget

The trust fund recovery penalty punishes a decision most owners make under pressure and with good intentions: keep people paid, deal with the IRS later. Amodio confirms that good intentions don't help once you know the taxes are unpaid. The fix is financial discipline: separate tax money the day it is withheld, forecast it as a fixed cost, and reconcile often enough to catch a missed deposit early.

If your cash plan only works when payroll tax money is treated as available, it's time to restructure before the IRS gets involved. Explore TaxesZenPro's Fractional CFO Services for a cash-flow review that separates tax liabilities from operating cash and builds a forecast you can run payroll on.


This article is for general information only and is not individual tax or legal advice. How these rules apply depends on your specific facts. TaxesZenPro is not a law firm.


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