What would happen if your company failed to pay the IRS payroll taxes when they're due? You could be on the hook for penalties and, if you're 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.
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:
For example, if your company is required to make a $10,000 payment and the payment is two weeks late, and the IRS hasn't 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's assessed if there's 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 doesn't 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.
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 don't 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're 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 doesn't exceed two years. Of course, the IRS must sign off on your plan, which is why it's 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 won't come after you for back taxes and penalties.
Payroll taxes are an unavoidable obligation, but your company doesn't have to incur unnecessary costs by triggering penalties. If you can't pay the full amount owed, contact the IRS (and your tax advisor) as soon as possible to discuss your options.
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