Most of the payroll problems that end up in front of us did not start with fraud or even with carelessness. They started with a business having a slow month and choosing, reasonably enough at the time, to make payroll and send the tax deposit a little late. The IRS treats that decision very differently than a late business tax return.
Why payroll taxes are treated differently
When you withhold income tax, Social Security and Medicare from an employee paycheck, that money is not yours and it never becomes yours. It is held in trust for the government on the employee behalf, which is why it is called the trust fund portion. Using it to cover rent or inventory, even briefly, is spending someone else money.
That is the reason enforcement in this area is faster and harder than anywhere else in the code, and it is why a payroll tax balance can follow an owner personally after the business itself is gone.
The penalties, in order of how much they hurt
Failure to deposit. Tiered by how late the deposit is, and it escalates quickly, reaching 15 percent once the deposit is more than ten days past a notice demanding payment. This applies to the deposit being late, not the return.
Failure to file and failure to pay. Applied to the quarterly Form 941 and the annual Form 940 separately from the deposit penalty. They stack.
The Trust Fund Recovery Penalty. This is the one that changes lives. The IRS can assess the trust fund portion of the unpaid tax personally against any responsible person who willfully failed to pay it. Responsible person is broader than owner: it can include an officer, a bookkeeper or anyone with authority over which bills get paid. Willful does not require bad intent, only knowing the tax was due and paying other creditors instead. This penalty survives the closure of the business, and it is generally not dischargeable in bankruptcy.
The mistakes we see most
- Depositing on the wrong schedule. Monthly and semiweekly schedules are assigned based on a lookback period, and the schedule changes as payroll grows. Businesses often keep depositing monthly long after they should have moved to semiweekly.
- Filing the 941 but not funding the deposit. The return being on time does not help if the money never moved.
- Treating employees as contractors. Reclassification on audit produces back taxes, penalties and interest for every quarter involved.
- The owner who never runs payroll at all. S corporation owners taking distributions with no reasonable salary is one of the most reliably audited positions there is.
- Missing the state side. State withholding and unemployment have their own schedules, their own penalties and their own collection powers.
If you are already behind
The first priority is to become current going forward, even before the old balance is addressed. The IRS will not agree to a resolution on back payroll taxes while new deposits are being missed, because from its perspective the harm is ongoing. Getting current is what makes everything else possible.
From there the path depends on the size of the balance and the health of the business. Installment agreements are available for payroll balances. Penalty abatement is often achievable on first occurrences. Where a Trust Fund Recovery Penalty interview has been scheduled, it should not be attended without representation, because how the questions about check signing authority and payment decisions are answered determines whether the liability attaches to you personally.
Prevention is cheaper than resolution
Every case in this article is avoidable with a payroll process that funds the deposit at the same time it funds the paycheck. That is the entire discipline. If payroll is being run out of the same account that covers the rest of the business, and deposits are made when someone remembers, the exposure is only a question of timing.
We run payroll for clients across the country, including the deposits and the quarterly filings, and we take on back payroll tax cases where the deposits stopped some time ago. Either conversation starts the same way, with a free consultation and a look at the account transcripts.
Not sure how this applies to you?
Every case turns on its own facts. Bring us the notice, the return or the balance and we will tell you where you stand, at no cost and with no obligation.