If you operate a business that collects payroll taxes from employees, here's a warning: Regardless of what your corporate financial situation is, don't borrow from the withholding tax fund. If that money isn't there when it's due, Uncle Sam will crack down hard. All businesses face downturns when cash flow dries up. It may be tempting to look at payroll tax money as an easy fix to a cash crunch. "I'll send it in later," you may think. But when it comes to bad ideas, this is one of the worst.
If the due date for making payroll tax deposits arrives and the money isn't sent ... the IRS will take action against the responsible parties. That money belongs to your employees and is meant to be held in a trust fund until deposited to pay income tax, Social Security and Medicare taxes.
Don't assume the corporate veil will shield you or other corporate officers. Payroll taxes are one area where you cannot escape personal liability.
Suppose your business, which has five corporate officers, comes up $100,000 short in unpaid trust money. The IRS has to decide who willfully failed to make the payments. But often, the tax agency goes after the person who is the easiest to collect from. You may be unaware the tax deposits weren't made. So if it turns out your four partners flee, you may be held responsible for the whole $100,000.
If there isn't enough money to pay the bill, the IRS can attach your business bank accounts or assets. If there's still a shortfall, you may find your business shut down and your assets seized and auctioned off. The IRS wants every cent.
Pretty bad news, right? There's more. Even if your firm files for bankruptcy, the debt is not dischargeable.
Will the government send violators to jail? Not usually. But if the IRS sees a pattern of repeated violations, it can launch a criminal investigation, which could lead to prison.
The repercussions can spread beyond the company. There are legal precedents that allow the IRS to collect from, say, banks and financial institutions that lend you money to pay those taxes. And the agency can go after partners and other corporate executives, even if they weren't active in running the company.
The easiest way out of a payroll mess is to avoid getting into one in the first place. If you're involved in a small- or medium-sized business, it can be a good idea to hire an outside service to handle payroll duties. A good payroll service provider relieves you of an enormous burden by cutting the checks, making the deductions, taking care of the tax payments and handling recordkeeping. But don't be lulled into feeling like your payroll is on autopilot. Payroll needs regular monitoring. If a shortfall occurs, your company, not the payroll provider, will bear the ultimate responsibility.
The fine used to be called the "100 Percent Penalty" until the tax agency tried to soften its image and renamed it the less ominous "Trust Fund Recovery Penalty." But the result is the same: An officer, business owner or other responsible employee can personally be assessed as much as 100 percent of the amount. And that doesn't include interest.
The IRS has to prove that you "willfully" failed to turn over withheld taxes. In one case, the Court noted that willfulness was evident simply because the taxpayer made payments to other creditors ahead of the IRS. (Edward J. Loew, 2002-1 USTC 50,126; U.S. Court of Appeals, 9th Circuit)
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