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The One-Hundred Percent (100%) Penalty- IRS and EDD versions

By Robert S. Schriebman, SJD

Corporations as well as LLCs must pay quarterly IRS and EDD payroll taxes for employee withholding. These are known as “trust fund” taxes. Back when Franklin D. Roosevelt was president, and America was recovering from the Great Depression, Congress created a forced fictionalized system whereby employers held withholding taxes “in trust” for both the employee and the federal government. If the corporate employer failed to withhold or pay over the withheld payroll taxes to the IRS, Congress gave the IRS the ability to disregard the corporate entity and hold certain individuals personally responsible for those unremitted taxes. Today we not only have corporations but we have LLCs as well. The same remedy applies to LLCs as it does corporations – the IRS can disregard the corporate entity and go after the so called responsible individuals.

The California Employment Development Department (EDD) has the same rules as the IRS when it comes to holding a responsible person personally liable for unremitted state payroll taxes – only the EDD version is proportionately much more severe than its IRS counterpart. Let me explain.

Internal Revenue Code § 6672 states in part that any person required to collect, truthfully account for, and pay over employment taxes may be personally liable for those taxes. This law used to be known as the “one-hundred percent penalty.” Recent changes in the IRS code now refer to this assessment as the Trust Fund Recovery Penalty (TFRP).

The responsible individual can not hide behind the corporation or LLC. However, the IRS is limited to collecting only those taxes that have been withheld from an employee’s paycheck. This usually means federal income taxes and the employee’s portion of Social Security taxes. The IRS can not hold the individual responsible for the corporate-employer’s portion of matching payroll taxes. Also, the IRS can not hold the responsible person personally liable for corporate level delinquencies, penalties, and interest. As a rule of thumb, the responsible person has personal exposure to only about two-thirds of the corporate or LLC total bill. The IRS assesses daily compounding interest on deficiency, but until the responsible person is actually and finally assessed, he or she is not liable for any accruing interest.

The IRS version of the TFRP is not as severe as assessments made by the EDD. The EDD version of the TFRP is found in § 1735 of the California Unemployment Insurance Code (CUIC). This law says in substance that any officer, major stockholder, or other person having the responsibility of EDD payroll tax compliance who willfully fails to comply with EDD withholding laws is personally responsible for one-hundred percent (100%) of every penny owed by the corporation or LLC. In other words, if the corporation or LLC owes the EDD $80,000 in delinquent payroll taxes and $20,000 in accrued penalties and interest, the EDD has the right to hold the responsible person personally liable for $100,000! The EDD will file a tax lien against the charged person and proceed to collect what its owed through enforced collection if necessary.

The difference between the IRS and EDD versions of these penalties is that the EDD is truly a one-hundred percent penalty.

I am often asked what to do with limited funds when a corporation owes both the IRS and the EDD for delinquent payroll taxes. My advice has consistently been to take the limited funds and pay off the EDD first. Theirs is a true one-hundred percent penalty.

© Copyright 2011. No part of this article may be taken and used in any way whatsoever without the express written consent of Robert S. Schriebman

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure”, both published by Commerce Clearing House.