Designating Payments to the Trust Fund Portion: The Letter That Protects Owners

A Form 941 balance has two kinds of tax in it. The trust fund portion is the income tax withheld from employees plus the employees' share of Social Security and Medicare. The non-trust fund portion is mainly the employer's own share of Social Security and Medicare. Then there are penalties and interest stacked on top.

Only the trust fund portion can become personal through the Trust Fund Recovery Penalty. IRM 5.17.7.2.6 is explicit that the TFRP does not apply to direct taxes such as the employer's portion of FICA or FUTA.

So when a business pays down its payroll tax debt, where the money goes is not an accounting detail. It decides how much the owners and officers can be personally assessed.

The Default Rule: The IRS Picks

IRM 5.7.4.3.1 sets out the sequence the IRS uses for undesignated payments on an employment tax period:

1. non-trust fund portion of tax (employer's share of FICA);
2. trust fund portion of tax (withholding and employee's share of FICA);
3. assessed lien fees and collection costs;
4. assessed penalty;
5. assessed interest;
6. accrued penalty to the date of payment; and
7. accrued interest to the date of payment.

The IRM then explains which steps apply to which kinds of payments. Federal tax deposits, and payments made on or before the due date, go to steps 1 and 2. Partial payments after the due date and before assessment go to steps 1, 2, 6 and 7. Partial payments on or after assessment, and involuntary payments like levy proceeds, run through all seven steps.

Notice where the trust fund portion sits. Second. An undesignated payment pays the employer's share first. And once assessments exist, later undesignated payments are spread across penalties and interest too.

There is a second layer. When a business owes several periods and sends a partial payment without written instructions, IRM 5.7.4.3 says the IRS applies it in the manner that serves the best interests of the government, which may include applying it first to non-trust fund modules such as Form 1120 or Form 940. IRM 5.7.4.4 adds that undesignated payments are usually applied against the period with the earliest collection statute expiration date.

The Exception: Voluntary Payments You Designate

The last line of the IRM 5.7.4.3.1 table is the one that matters: designated payments are applied as designated. The IRM ties this to Revenue Procedure 2002-26, which it cites as the IRS guidance on application of payments.

IRM 5.7.4.4 spells out the requirements: the payment must be voluntary, and the designation must be specific, in writing, and made at the time of the payment.

Each word does work.

• Voluntary. Levy proceeds and other involuntary collections cannot be designated by you. They follow the IRS sequence.
• Specific. IRM 5.7.4.4 says that if a business sends a payment marked "trust fund" without specifying the tax period, that is not a specific designation. The IRS will apply it to the oldest collection statute employment tax period. Name the form, the period and the portion.
• In writing. A phone call to the Revenue Officer does not count.
• At the time of payment. You cannot pay now and designate next month.

The Language the IRS Uses

When a responsible person pays on behalf of the business with a non-business check, IRM 5.7.4.4 tells the Revenue Officer to get a signed statement in this form:

"I/We {Name(s)}, hereby tender payment of ${Amount} and specifically request that such funds be applied to the trust fund tax liability of {Business Name}, {Business EIN} for the period(s) ending {List Each Period}."

The IRM explains that the statement protects the government if the responsible person later files a refund claim arguing that a personal payment was misapplied. It also notes that if statements accompanying unsolicited payments are to be accepted as adequate, they must clearly indicate the intent to designate, similar to that language.

For a business check, use the same structure: company name, EIN, Form 941, the specific quarters, and the instruction that the payment be applied to the trust fund portion.

Where This Shows Up in Real Cases

During the Revenue Officer's first visit

IRM 5.7.4.4 says that when efforts to collect from the employer have been unsuccessful, the Revenue Officer should tell responsible persons they have two options: pay the withheld tax liability on behalf of the business, or have the TFRP assessed against them. The IRM specifies that the payment is the total amount of the trust fund balance, and the Revenue Officer is not to solicit partial designated payments intended only to push the balance below internal thresholds. The TFRP investigation continues while the IRS waits for designated payments.

If you can raise the money, paying the trust fund balance with a proper designation can end the personal exposure for that period. If you pay after Letter 1153 has gone out, IRM 5.7.4.4 tells the Revenue Officer to review the refund freeze on your personal account once the payment posts.

When the business is selling assets

Proceeds from a voluntary asset sale, sent with a designation, can be steered to trust fund taxes. Levy proceeds from the same assets cannot. Timing matters.

Before assessment, by an individual

IRM 5.7.7.3 describes how the IRS posts payments a responsible person makes before the TFRP is assessed, as advance payments tied to the pending penalty. That is a different mechanism from paying the business's account. Decide which you are doing, and say so in writing.

A Limit: Business Installment Agreements

Designation has an important restriction. IRM 5.7.4.8.1 states that while under an approved installment agreement, a corporation may not designate its monthly installment payment to the trust fund portion of the tax, cross-referencing IRM 5.14.7.5. If designation is part of your strategy, think about it before the agreement is signed, and about payments outside the agreement. See our guide to business trust fund payment plans.

Do Not Confuse This With Deposit Designation

There is a separate designation right for federal tax deposits under IRC 6656(e). It lets a depositor designate the period within a quarter to which a deposit applies, for purposes of the failure-to-deposit penalty, during the 90-day period beginning on the date of a penalty notice. That is a penalty-reduction tool, not a trust fund allocation tool. Our failure-to-deposit penalty guide covers it.

Put It in Front of the Revenue Officer, Too

A designation letter that goes to a lockbox with the check is still a designation. But if a Revenue Officer is assigned, send a copy of the designation and proof of payment directly to them as well. The Revenue Officer is the person calculating the trust fund balance for the Form 4183 recommendation, and IRM 5.7.4.5 requires that calculation to be updated before the recommendation goes to the manager. Make it easy for the update to include your payment.

Keep a log for the business: date, amount, check or confirmation number, form, period, and the exact designation language used. When the IRS's calculation sheet arrives, you will compare it line by line against that log. If a designated payment shows up on the employer's share instead of the trust fund portion, you will have the paper to prove what you asked for.

Check How Past Payments Were Applied

The Revenue Officer is supposed to show you the TFRP computation, including the IRS's calculation sheet breaking down transactions for each period, during the investigation and with Letter 1153. Review it payment by payment. Look for:

• designated payments that were not applied as designated;
• deposits applied to the wrong quarter;
• payments made by a responsible person that were not credited; and
• business payments made after assessment that should reduce the TFRP balance.

IRM 5.7.4.2.3 also says that if you provide payroll records showing the composition of a deposit and that it was timely, it may lower the TFRP calculation.

The firm's main site has more on how payroll tax debts are resolved.

One sentence, written correctly and sent with the check, can move thousands of dollars of exposure off your personal balance sheet. Write it every time. Questions? Call (813) 229-7100. Let's talk.