Overview of "Trust Fund" Taxes
Why It's Important to Collect and Pay Sales Tax and Employment Taxes
If you search for the term "trust fund taxes" on the internet, you will see two different kinds of taxes:
Taxes on trust funds. A trust fund is a special kind of legal entity that holds money on behalf of a person, group or organization. While trust funds are often set up to shield money from taxes, taxes on trust fund distributions have unfavorable tax rates.
Trust fund taxes. These are taxes that are collected by a business as a result of its activity and then held in trust until the taxes must be paid to a government entity. The two most common types of trust fund taxes are employment taxes and sales taxes.
This article will deal with the requirements of trust fund taxes for businesses.
How Trust Fund Taxes Work
In general, the purpose of a trust fund tax is for a business dealing with a government agency in collecting taxes and holding them in the business's accounting system until the taxes are paid to the government agency.
- The IRS oversees federal income taxes and FICA "(Social Security/Medicare) taxes you have withheld from employee pay,
- Each state tax agency regulates sales taxes you have collected from customers on the sales.
If you are collecting money from employees, you are collecting their income taxes and their retirement benefits. The employees trust that you will make these payments. In the same way, customers are trusting your business to make the sales tax payments to the state. That's why they are called trust fund taxes.
What Happens If You Don't Pay Trust Fund Taxes
One of the most common ways businesses get into trouble with the IRS and state tax departments is to use these accumulated liabilities for their own businesses instead of paying them when they are due.
"Robbing Peter to Pay Paul" isn't a good idea. At its worst, if it's intentional it's tax fraud. The penalties work differently depending on the type of tax.
Federal Laws and Penalties - Employment Taxes
Federal law covers penalties for non-payment of federal income tax and FICA taxes. Failing to turn over employment taxes to the U.S. Treasury can result in large penalties, and the longer it takes to pay, the greater the penalty.
Several penalties apply to employment taxes:
A Failure-to-Deposit penalty for not complying with the deposit rules and deadlines, including using electronic funds transfer (EFT) to make deposits. Penalties increase with lateness and with the amount of undeposited funds.
The IRS can also impose a penalty is called a Trust Fund Recovery Penalty (TFRP) which may be assessed against anyone who is responsible for collecting or paying payroll taxes and who willfully (with intention) fails to collect or pay them.
The IRS identifies one or more "responsible person(s) who have the duty to pay these taxes, were aware of their responsibility and didn't do it because they "intentionally disregarded the law" or were "plainly indifferent to its requirements.
The TFRP amount is 100% of the unpaid tax. If the unpaid taxes can't be collected from the business, the (not the business) responsible for the payment of trust fund taxes. If the IRS decides that the responsible person or people have willfully failed to collect or pay taxes, they can take collection action against personal assets, including filing a federal tax lien or seizure action .
To avoid penalties for unpaid employment taxes:
- Create a system with a payroll tax calendar hat helps you remember due dates, and
- Get business tax software to keep trust fund tax you withhold or collect separate.
A Failure-to-File (FTF) penalty is applied for each whole or part month that a return isn't filed when it should have been. The maximum penalty is generally 25% of the tax due.
The IRS also accrues interest on unpaid balances due.
State Laws and Penalties on Sales Taxes
Each state has its own laws and penalties for unreported and uncollected sales taxes.
New York, for example, imposes civil penalties for
- Filing late and failing to file a return,
- Filing the return on time but not paying the tax due
The penalties increase with the amount of the tax due and the lateness of the filing.
New York also imposes criminal penalties, including fines and a jail sentence, for
- Failing to "make, render, sign, certify, or file any return or report,"
- Willing failing to collect state and local sales tax required to be collected.
- Wilfully failing to pay state and local taxes collected
- With the intent to evade tax, willfully fail to pay any tax.
New York also has penalties for failing to get or display a Certificate of Authority (a sales tax certification from the state.
Florida has similar penalties and includes a 100% penalty for willful failure to collect sales taxes. The third offense becomes a felony, with the level of felony depending on the amount of uncollected tax.
Check with your state's taxing authority to find the due dates for sales tax reports and payments.
Sales Taxes as Trust Fund Taxes
Sales taxes also work as trust fund taxes. Your business is collecting money from customers for the products or services you sell. They are trusting that you are (a) collecting the correct amount, and (b) that you are paying these taxes to the state revenue department. At each step along the way, you have a responsibility. You must:
- Know if you must collect sales tax in a specific state because you have a nexus or sales tax presence in that state.
- Find out if what you're selling is taxable in your state,
- Make sure you are collecting the correct amount of tax,
- Collect the tax every time,
- Set aside the taxes you collect,
- Report what you owe to your state, and
- Pay the required amount of sales taxes.
Employment Taxes as Trust Fund Taxes
Your business as an employer is required to collect employment taxes, taxes that must be paid by both employees and employers. Employment taxes include federal income taxes, state income taxes (if applicable), FICA taxes (Social Security and Medicare taxes), federal unemployment taxes, and self-employment taxes.
Accounting for Trust Fund Taxes
The taxes must be held in a separate account (usually an account called a payables account) so that it's clear that the tax is an accrued (accumulated) liability for accounting purposes and should not be used for any other purpose by the business.
Here's an example of how the accounting works for sales taxes:
When you record a sale, you must record the sales tax separately from the income in the category of "sales tax payable;" it's not income to you. If you sold something for $10 and the sales tax was 7 percent, you would collect $10.70. The $10 is recorded as income and the 70 cents as "sales tax payable." At the time required by your state (usually quarterly), you would add up all of the sales taxes payable and send them in one lump sum to the state.
Many businesses have a separate bank account for payroll, partly to keep these trust fund taxes separate so the money isn't spent by mistake.
IRS. "Publication 15 (Circular E), Employer's Tax Guide." Introduction, Page 9. Accessed Dec. 2, 2019.
IRS. "Trust Fund Taxes." Accessed Dec. 2, 2019.
IRS. "Publication 15 (Circular E), Employer's Tax Guide." Depositing Taxes, page 25. Accessed Dec. 2, 2019.
IRS. "Publication 15 (Circular E), Employer's Tax Guide." Deposit Penalties, Page 15. Accessed Dec. 2, 2019.
IRS. "Employment Taxes and the Trust Fund Recovery Penalty (TFRP)." Accessed Dec. 2, 2019.
IRS. "Publication 15 (Circular E), Employer's Tax Guide." Filing Form 941 or Form 944, page 30. Accessed Dec. 2, 2019.
New York State Department of Taxation and Finance. "Sales and Use Tax Penalties." Accessed Dec. 2, 2019.
Florida Department of Revenue. "Penalty and Interest Provisions for Taxes Administered by the Florida Department of Revenue." Sales and Use Tax. Page 11. Accessed Dec. 2, 2019.
Principles of Accounting. Chapter 12. "Current Liabilities." Accessed Dec. 2, 2019.