What exactly is the Trust Fund Penalty?

First let me clarify that the Trust Fund Penalty is not really a penalty added to tax owed but is a portion of the payroll taxes owed by a corporation. The Trust Fund Penalty only applies to corporations, not to sole proprietorships or partnerships. When the corporation withholds taxes from an employee’s paycheck, the corporation is holding that money in trust for the employee and is to be paid to the US Government on the employee’s behalf. Instead of the employee paying the IRS directly the taxes he owes out of his check, the corporation withholds it and pays it to the IRS. The corporation also pays an additional amount equal to the FICA amount the employee owes. The trust fund portion of the taxes is simply the amount withheld from the employee. If a corporation owes payroll taxes and does not pay them, the IRS will, of course, first look to the corporation to pay the total amount. If the corporation cannot pay the taxes, then the IRS will look to anyone in the corporation who had the authority to direct where and how money was spent.   That person (or persons) is liable for the trust fund portion of the taxes, but not the matching FICA portion. This is the “penalty” owed by the individual for authorizing the employee’s money to be paid to someone else other than the IRS.