When cash flows are tight, some small businesses treat late income tax payments as a loan from the IRS. If you try to do the same thing with payroll taxes, you could soon find yourself in serious trouble.
What are payroll taxes?
Payroll taxes include income, Social Security, Medicare, and federal unemployment taxes withheld from employee paychecks. Even though the employer makes the payroll tax deposit, the IRS considers this money to belong to the employees as part of their wages.
What is the penalty for late payroll tax deposit?
The penalty for late payment of payroll taxes varies based on how late the payment is. There are four separate charges that you could have to pay.
Failure to Deposit Penalty
This is a fixed percentage based on the amount of payroll tax you failed to deposit on time.
| Number of Days Late | Percent Penalty |
|---|---|
| 1-5 | 2% |
| 6-15 | 5% |
| 16+ but before receiving an IRS notice | 10% |
| More than 10 days after first IRS notice | 15% |
Failure to File Penalty
If you fail to file a Form 941 payroll tax return, the penalty is 5% per month until you file the return up to a maximum penalty of 25%. To avoid the late filing penalty, you should always file your employment tax returns on time even if you can’t pay.
Failure to Pay Penalty
There is an additional penalty of 0.5% of the unpaid tax for each month you don’t pay. This penalty increases to 1% for each month after you receive a notice of intent to levy. The maximum penalty is 25%.
Interest
Interest is added on top of penalties and accrues without limit until you pay your tax liability in full. The interest rate varies based on the current federal funds rate.
Willful Failure to Pay
If the IRS finds that you willfully failed to pay or collect payroll taxes, you could be facing felony charges from the Department of Justice. According to Internal Revenue Code Sec. 6672, a failure to remit trust fund taxes is willful if it is a voluntary, conscious, and intentional act.
The IRS usually doesn’t pursue willful failure to pay except in egregious situations.
If you chose to not pay payroll taxes for the first time because you didn’t know better and had to pay your business rent or get evicted, you probably won’t be charged. If you didn’t pay payroll taxes and bought yourself a boat, there’s a good chance you could be charged.
Only a lawyer, not a CPA, can advise you on the possibility of criminal charges in your situation.
Can you get a payroll tax penalty if you don’t have a business bank account?
You have to pay payroll taxes by electronic funds transfer. If you don’t have a bank account, you can’t pay. If you can’t pay, your payments are late and subject to penalties.
The IRS may remove your penalties if you explain why you don’t have a bank account and what you did to try to get one.
For example, a marijuana dispensary may have difficulty because many banks won’t work with companies that are violating federal drug laws even if the activity is legal in that state. Another situation the IRS might accept is if you suddenly had your bank account closed and had to get a new one.
Can you get a payroll tax penalty removed?
It is difficult but possible to get a payroll tax penalty removed. To do so, first, you need to get caught up on your employment tax returns and payments.
You will then need to show reasonable cause why you didn’t pay. Reasonable cause is generally not financial hardship. It’s something like your CPA gave you bad advice or your CFO quit and no one knew to make the payment.
You can also dispute the fact that you were charged a penalty or the amount of the penalty. For example, you might disagree with the IRS on which federal deposit schedule your company is required to use.
You can either call the IRS or send in a written explanation. If the penalties are high, you may want to get a CPA or lawyer to respond for you.
Employee Retention Credit Penalty Relief
If you claimed the Employee Retention Credit but the IRS was slow to process it, you may receive a penalty for not paying taxes that should have been covered by the credit. You may be able to avoid the penalty by claiming the IRS processing delays as reasonable cause.
What is the trust fund recovery penalty?
The trust fund recovery penalty allows the IRS to hold owners, managers, and other responsible individuals personally liable for payroll taxes.
When you withhold payroll taxes from your employee’s wages (or are supposed to withhold it), that money belongs to the employee not to you. You are holding it in trust for the employee to transfer it to the government. The IRS considers using this money for other business purposes as essentially theft.
The trust fund recovery penalty allows the IRS to collect 100% of unpaid payroll taxes and applicable penalties for anyone who willfully causes them to not be withheld and paid to the IRS. It applies only to the employee, not employer, portion of payroll taxes.
The trust fund recovery penalty is a personal penalty, and having a corporation or LLC does not protect the business owners from it.
A responsible party under the trust fund recovery penalty can be an:
- Owner,
- Manager,
- Accountant,
- Or other person who is responsible for handling payroll and tax deposits.
Willful means that:
- You knew or should have been aware of the law,
- And you intentionally ignored it or were plainly indifferent to it.
Again, because the money does not belong to you, being short on cash and using it to pay other bills is a willful violation and subject to the trust fund recovery penalty.
How are payments applied when you’re behind on payroll taxes?
The IRS will generally apply payments to your most recent payroll tax liabilities. If you wish to make additional payments to pay down the debts with the highest penalties first, you will need to designate your payment as being towards a specific debt.
Can you get a payment plan?
If you can’t pay what you owe, you may be able to qualify for an IRS installment agreement to make monthly payments.
You will still have to pay penalties and interest on the unpaid balance just like when you pay off another loan or credit card. However, you’ll no longer owe the failing to file penalty, and the IRS will pause other collections actions if you pay your payment plan and make timely deposits going forward.
Conclusion
Not paying payroll taxes on time is a serious issue. The IRS considers payroll tax money to belong to the employees not the business. The penalties are high to match the fact that the IRS thinks you wrongfully used that money.
If you can’t pay your payroll taxes or got behind on payroll taxes, talk to a CPA or attorney as soon as possible. You may also want to review your business accounting processes to see if you can find ways to better manage your cash flow.
