What would happen if your company failed to pay the IRS payroll taxes when they are due? You could be on the hook for penalties and, if you are treated as a “responsible party,” held personally liable for unpaid taxes. Fortunately, your business can avoid dire tax complications by following the rules and, if problems emerge, keeping the lines of communication open with the IRS. Also, working with experienced tax professionals is critical.
3 Potential Pitfalls
Payroll taxes are made up of amounts withheld from employee paychecks, plus an employer’s share of those taxes. Primarily, this includes income tax withholding and FICA tax, attributable to Social Security and Medicare taxes, as well as federal unemployment taxes.
These taxes pose three potential pitfalls for employers:
1. IRS late payment penalties. The federal government has established due dates throughout the year for depositing and reporting payroll taxes to the IRS. Usually, employers must deposit taxes monthly, though some larger corporations are required to make semiweekly deposits. Adhering to this schedule requires discipline. Failure to pay taxes on time can result in penalties based on a percentage of your tax liability. For example, you would likely owe:
- 2% for one to two days late,
- 5% for six to 15 days late,
- 10% for 16 or more days late or if you pay within 10 days of the first issuance of an IRS notice, and
- 15% if you pay after 10 days of the first issuance of an IRS notice.
For example, if your company is required to make a $10,000 payment and the payment is two weeks late, and the IRS has not issued a late payment notice, your penalty would be $500 (5% of $10,000).
2. The Trust Fund Recovery Penalty (TFRP). The TFRP is widely considered one of the most onerous provisions in the federal tax code. It is assessed if there is a “willful failure” to pay payroll taxes. Briefly stated, if a responsible party — such as a business owner — willfully fails to collect payroll taxes from employees or deliver those funds to the IRS, that party may be held personally liable for tax liability. This means responsible parties could have to pay 100% of taxes due out of their own pockets.
A responsible party may be anyone who has the duty to perform and power to direct collection, accounting, and payment of trust fund taxes. Usually, this is a business owner, but liability can extend to officers and executives. In rare cases, rank-and-file employees, including bookkeepers, have been deemed responsible parties. The issue of responsibility is frequently contested in court.
The IRS has a similarly broad interpretation of willful failure. Notably, a failure does not have to be intentional. For example, a TFRP may be assessed if you knew — or should have known — about the payroll taxes at issue. Unfortunately, a TFRP often is imposed because a struggling business owner or officer has prioritized payments to creditors. The penalty can be a painful reminder that you should always pay the IRS first.
3. State and local penalties. Your company also needs to comply with the rules of your state and, possibly, your municipality. These governments might require you to withhold and deposit income tax withheld from employee wages. As with FICA, state income taxes are due monthly or semiweekly and are reported quarterly. Due dates and penalties relating to state and local taxes vary by jurisdiction, so check with your tax authority or your tax advisor.
Possible Solutions
The best way to avoid payroll tax problems and penalties is to pay the full amount due on time. Even if you have to use a credit card and incur interest because you do not pay the full balance, this may be the best route. An alternative is to possibly obtain a loan using business assets as collateral.
If you are unable to pay the full amount on time, you may be able to reduce overall tax damage with a payment plan. Usually, employers can set up a monthly payment plan addressing payroll taxes if they owe less than $25,000 and the repayment period does not exceed two years. Of course, the IRS must sign off on your plan, which is why it is a good idea to work with a tax professional when preparing your proposal.
Another potential option is the IRS’s Offer in Compromise (OIC) program. It may allow you to settle a tax debt with the IRS for less than the full amount owed. Once obligations under the OIC program are met, your business is off the hook. The tax agency will not come after you for back taxes and penalties.
Unavoidable Obligation
Payroll taxes are an unavoidable obligation, but your company does not have to incur unnecessary costs by triggering penalties. If you cannot pay the full amount owed, contact the IRS (and your tax advisor) as soon as possible to discuss your options.
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Disclaimer of Liability
Our firm provides the information in this article for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisors. Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this blog are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability and fitness for a particular purpose.
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