The Trust Fund Penalty in California Payroll Audits – What It Is and How to Avoid It
The Trust Fund Penalty in California Payroll Audits – What It Is and How to Avoid It
If you’re a business owner in California and you’re behind on payroll taxes in California, you’re at risk of more than just back taxes and interest. The IRS—and in many cases, California state agencies—can hold you personally responsible for unpaid trust fund taxes. This is known as the Trust Fund Recovery Penalty (TFRP).
Whether you’re being audited by the IRS payroll tax enforcement, the EDD, or another California taxing agency, understanding how trust fund penalties work—and how to defend against them—is critical to protecting both your business and personal assets.
At Boulanger CPA and Consulting PC, we represent business owners across Orange County and California who are facing payroll tax audits, enforcement actions, and trust fund assessments. This guide will explain:
- What the trust fund penalty is
- Who can be held personally liable
- How it applies in California audits
- How to avoid and defend against it
What Are Trust Fund Taxes?
Trust fund taxes refer to money withheld from employees' paychecks that you’re required to remit to the government on their behalf.
These include:
- Federal: Social Security, Medicare (FICA), and federal income tax withholding
- State: California Personal Income Tax (PIT) withholding, SDI (State Disability Insurance), and UI/ETT contributions
This money isn’t yours to spend. You’re holding it in “trust” for the government. If you don’t deposit it correctly and on time, serious consequences follow. Understanding EDD payroll tax audit triggers can help you prevent these situations.
What Is the Trust Fund Recovery Penalty (TFRP)?
The TFRP is a federal penalty enforced by the IRS under IRC §6672, allowing the IRS to personally assess unpaid trust fund taxes against business owners, officers, and responsible individuals.
It’s not just a business debt—it follows you individually.
The IRS can:
- Assess the debt personally against you
- File liens against your personal property
- Levy your personal bank account
- Offset your future tax refunds
- Continue collection even after the business closes
Is There a California Version of the Trust Fund Penalty?
Yes—California’s EDD can also pursue personal liability for unpaid payroll taxes under California Unemployment Insurance Code §1735.
That means in addition to IRS enforcement, the EDD can personally assess you for:
- Unpaid PIT
- SDI
- UI/ETT contributions
- Penalties and interest
The Franchise Tax Board (FTB) may also get involved once the debt becomes final, making awareness of California FTB audit triggers critical.
Who Can Be Held Personally Liable?
The IRS and EDD will look for individuals who:
- Had
financial control or signature authority over business accounts
- Made decisions about which creditors to pay
- Knew that taxes were not being paid
- Willfully allowed the non-payment to continue
This includes:
- Business owners
- CFOs or controllers
- Bookkeepers with check-signing authority
- Outside payroll providers (in rare cases)
Even passive owners or LLC members can be held liable if they were aware of payroll tax issues. For guidance on classification risks, see EDD reclassification penalties explained.
How the Trust Fund Penalty Is Assessed
Federal (IRS):
- The IRS will conduct a
Form 4180 Interview to establish who was responsible.
- If you’re found liable, you’ll receive
Letter 1153 and
Form 2751.
- You have the right to appeal—but only within a short window.
State (EDD):
- EDD may issue a
Personal Assessment Determination Notice.
- If you ignore it, it becomes final—and they can levy your personal assets.
Real-World Example
A business owner in Orange County fell behind on payroll deposits during COVID. They used withheld employee taxes to cover rent and vendors. The IRS assessed a $124,000 trust fund penalty—personally—against the owner. We negotiated a structured payment plan and helped the client avoid liens and further enforcement, but the damage could have been far worse had they waited.
How to Defend Against the Trust Fund Penalty
If you’re facing a trust fund assessment:
1. Hire a CPA Immediately
Don’t try to navigate this alone. We protect you from making self-incriminating statements.
2. Challenge Responsibility
We may be able to prove you were not a “responsible party” or that your actions were not willful.
3. Dispute the Amount
We review IRS or EDD calculations, challenge unsubstantiated penalties, and seek reduction or abatement.
4. Negotiate Payment Options
If the penalty is valid, we can still negotiate installment agreements, CNC (Currently Not Collectible) status, or settlement in extreme hardship cases.
For comprehensive strategies, see our guide on explore more in Defend What’s Yours.
How to Avoid the Trust Fund Penalty
- Use a reputable,
full-service payroll provider (not just a bookkeeper)
- File and deposit payroll taxes on time, every time
- Do not borrow from tax withholdings to pay other bills
- Monitor payroll accounts and don’t delegate blindly
- If you’re falling behind—get help immediately
Local Representation for IRS and EDD Payroll Tax Issues
We serve business owners in:
- Orange
- Irvine
- Santa Ana
- Costa Mesa
- Anaheim
- Inland Empire
…and across the state of California
Whether you’ve received a notice or just suspect a problem, we’re here to help.
Facing a Trust Fund Penalty? Let’s Talk.
This isn’t something you can ignore. Trust fund penalties pierce the corporate veil and follow you personally. Don’t wait until your bank account is frozen.
📞 Call (657) 218-5700 or Book Your Confidential Consultation Now
Frequently Asked Questions
What is the Trust Fund Recovery Penalty?
The Trust Fund Recovery Penalty (TFRP) is when the IRS or EDD holds business owners or responsible individuals personally liable for unpaid payroll taxes withheld from employees.
Who can be held liable for payroll tax debt?
Any responsible party who had authority over payroll decisions—owners, officers, bookkeepers, or managers—may be held personally liable for trust fund taxes.
How does California enforce trust fund taxes?
The California EDD enforces payroll tax compliance and can pursue responsible parties for unpaid withholdings, similar to the IRS.
Can both the IRS and EDD assess penalties?
Yes. The IRS and EDD operate separately, and both can assess penalties for unpaid payroll taxes, creating dual liability risks.
What defenses exist against the Trust Fund Penalty?
Defenses include proving you weren’t a responsible person, lacked authority over payroll, or that nonpayment wasn’t willful.
Can trust fund penalties be discharged in bankruptcy?
No. Trust fund payroll taxes are not dischargeable in bankruptcy, making resolution essential before debts escalate.
Should I hire a CPA for payroll tax defense?
Yes. Professional representation ensures your case is presented correctly, defenses are raised, and personal liability is minimized.
other articles of interest
- EDD Payroll Tax Help
- IRS Tax Relief Help
- California FTB Tax Relief
- Can You Settle Payroll Tax Debt with the EDD?
📣 About the Author
Marc Boulanger, CPA is the founder of Boulanger CPA and Consulting PC, a boutique tax resolution firm based in Orange County, California and trusted by high-income individuals and business owners across Southern California.
He is the author of Defend What’s Yours: A California Taxpayer’s Guide to Beating the IRS and FTB at Their Own Game, available now on Amazon. The book offers a step-by-step plan for resolving IRS and FTB tax debt without losing your business, your home, or your peace of mind.
With over a decade of experience resolving high-stakes IRS and State tax matters, Marc brings strategic insight to complex cases involving wage garnishments, bank levies, unfiled returns, and six-figure tax debts. He is known for helping clients reduce or eliminate tax liabilities through expertly negotiated settlements and compliance plans.
Marc is a Certified Public Accountant licensed in California and Oklahoma and holds the designation of Certified Tax Representation Consultant. He is a member of the American Society of Tax Problem Solvers (ASTPS) — the national organization founded by the educators and practitioners who have trained thousands of CPAs, EAs, and tax attorneys in IRS representation strategy.
Every case is handled with discretion, proven methodology, and direct CPA-led representation — not call center scripts.
📍 Learn more at www.orangecounty.cpa or call (657) 218-5700.
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