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've fallen behind on payroll taxes, 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, 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 your 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.
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, and they’re one of the most aggressive collection agencies in the country.
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.
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.
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
FAQ – Trust Fund Penalty in California
What taxes are considered “trust fund” taxes?
Federal income tax, Social Security, Medicare, California PIT, and other employee withholdings.
Can I be personally liable even if I didn’t own the business?
Yes. If you had control over finances or payroll, you may be deemed responsible.
Is the trust fund penalty dischargeable in bankruptcy?
Generally no. These penalties survive bankruptcy.
Can the IRS or EDD levy my personal bank account?
Yes—if the trust fund penalty is assessed personally.
How can I avoid being assessed?
Ensure your business is compliant. If you're unsure, have a CPA review your payroll tax history now.
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.
Marc The CPA's Tax Blog
