What Are Trust Fund Taxes?
When a business pays employees, it withholds income taxes and the employee's share of FICA (Social Security and Medicare taxes) from each paycheck. This money belongs to the government -- the business is holding it "in trust" until it is remitted. These are called "trust fund" taxes.
Trust fund taxes include:
- Federal income tax withholding -- the amount withheld from employee paychecks for federal income tax
- Employee share of FICA -- the employee's 7.65% contribution to Social Security and Medicare
Trust fund taxes do not include:
- Employer share of FICA -- the employer's matching 7.65% is the employer's own obligation, not trust fund
- Federal unemployment tax (FUTA) -- this is the employer's obligation
The critical rule: Trust fund taxes are always priority claims under 11 U.S.C. Section 507(a)(8)(C) and nondischargeable under Section 523(a)(1)(A). There is no timing test, no age threshold, and no exception. They survive bankruptcy in every chapter.
The Trust Fund Recovery Penalty (TFRP)
When a business fails to remit trust fund taxes, the IRS does not just pursue the business. Under 26 U.S.C. Section 6672, the IRS can assess the full amount of unpaid trust fund taxes against any individual who was a "responsible person" and "willfully" failed to collect or pay the taxes.
This is commonly called the "100% penalty" -- not because there is an additional penalty on top of the tax, but because the assessment against the individual equals 100% of the unpaid trust fund taxes. It is the same amount, assessed against a different person.
For a detailed discussion of responsible person analysis, willfulness, and defense strategies, see our Trust Fund Recovery Penalty page.
Personal liability: The TFRP creates personal liability for business owners, officers, and sometimes managers -- even if the business itself has been dissolved or has no assets. The IRS can pursue the individual's personal assets, wages, and bank accounts.
Payroll Taxes in Chapter 7
Chapter 7 provides no relief for trust fund taxes. They are priority claims that are nondischargeable. After your Chapter 7 case closes, you will still owe the full amount of trust fund taxes, plus any interest and penalties.
Chapter 7 may help with the employer share of FICA and FUTA if those taxes meet the timing rules (3-year rule, 240-day rule, 2-year filing rule). The employer share is not a trust fund tax and may be treated as a general income tax for discharge purposes. However, this is a nuanced area and not all courts agree on the treatment.
Payroll Taxes in Chapter 13
Chapter 13 is the far better option for dealing with trust fund tax debt. While the taxes cannot be discharged, Chapter 13 provides significant advantages:
- Structured repayment: Trust fund taxes must be paid in full through the plan (11 U.S.C. Section 1322(a)(2)), but you get 3-5 years to pay them.
- Stop collection: The automatic stay halts all IRS collection activity -- levies, garnishments, and liens -- while the plan is in effect.
- Penalty freeze: In most cases, additional penalties stop accruing once the bankruptcy is filed. Interest may continue on priority taxes, but the penalty bleeding stops.
- Combined resolution: Chapter 13 addresses all your debts -- trust fund taxes, other taxes, credit cards, medical bills -- in one plan.
- Protection from TFRP collection: If you are personally liable under the TFRP, the automatic stay protects you from IRS collection during the plan.
Example: You owe $45,000 in trust fund taxes from your business. In a 5-year Chapter 13 plan, that is $750/month just for the trust fund taxes, plus whatever is needed for other debts. Without bankruptcy, the IRS could levy your bank account, garnish your wages, and seize assets. Chapter 13 gives you a structured payment with protection from aggressive collection.
The Employer Share -- A Different Analysis
The employer's share of FICA (the matching 7.65%) and FUTA are not trust fund taxes. They are the employer's own obligation. For purposes of bankruptcy discharge, they are analyzed under the same rules as income taxes:
- If the employer share was assessed more than 240 days ago and the return was due more than 3 years ago and was filed more than 2 years ago, it may be dischargeable.
- If the timing rules are not met, it is a priority claim that must be paid in full.
This creates an important distinction in mixed payroll tax situations. The trust fund portion (employee withholding + employee FICA) is never dischargeable. The non-trust-fund portion (employer FICA + FUTA) may be dischargeable if the timing rules are met.
Practical Implications for Business Owners
- Chapter 7 is usually not enough: If your primary debt is payroll taxes, Chapter 7 will not help because the trust fund portion survives.
- Chapter 13 is the primary tool: Use Chapter 13 to structure repayment over 3-5 years while stopping aggressive IRS collection.
- Separate trust fund from non-trust-fund: Work with your attorney to identify exactly how much of your payroll tax debt is trust fund (nondischargeable) vs. employer share (potentially dischargeable).
- Check for TFRP assessment: If the IRS has assessed the TFRP against you personally, that personal assessment has its own timing. The 240-day rule applies to the date the TFRP was assessed against you, not the date the original business tax was assessed.
- Multiple responsible persons: If other people were also responsible persons, the IRS may be collecting from them too. Payments by co-responsible persons reduce your liability.
Frequently Asked Questions
Can payroll taxes be discharged in bankruptcy?
Trust fund payroll taxes (employee income tax withholding and employee FICA) can never be discharged. They are priority claims under 11 U.S.C. Section 507(a)(8)(C). The employer's share of FICA and FUTA may be dischargeable if they meet the standard timing rules for tax discharge.
What is the trust fund recovery penalty?
The TFRP (26 U.S.C. Section 6672) allows the IRS to assess unpaid trust fund taxes against any "responsible person" who willfully failed to collect or remit the taxes. It is called the "100% penalty" because the assessment equals the full amount of the unpaid trust fund taxes. It creates personal liability for business owners and officers.
Can I pay payroll taxes through a Chapter 13 plan?
Yes. Trust fund taxes must be paid in full through the Chapter 13 plan under 11 U.S.C. Section 1322(a)(2). You get 3-5 years to pay, the automatic stay stops IRS collection, and in most cases additional penalties stop accruing. This is the primary bankruptcy tool for managing trust fund tax debt.
Who is a responsible person for payroll taxes?
A responsible person is anyone with authority over the business's financial affairs, specifically the authority to determine which creditors get paid. This includes business owners, corporate officers, and sometimes managers or bookkeepers who had check-signing authority. The IRS can hold multiple people liable for the same trust fund taxes.
Related Resources
The Trust Fund Recovery Penalty -- deep dive on Section 6672
Section 523(a) Exceptions to Discharge -- nondischargeable debts
Nondischargeable Debts -- complete guide
Chapter 13 Plans -- how repayment plans work
Check Your Bankruptcy Discharge Eligibility
Use the free screener at 1328f.com to check whether federal timing bars affect your ability to receive a bankruptcy discharge.