Payroll Taxes IRS Dynamite
If you own a business with employees, each payroll period you must hold back from each employee’s paycheck:
- Federal and maybe state income tax, and
- FICA contributions (Social Security and Medicare).
How much income tax is withheld from each employee’s earnings depends on the number of exemptions claimed by the employee when he or she started working for you. The FICA contribution is a percentage of the employee’s gross earnings, which you must fully or partially match.
An employer turns over withheld taxes to a bank qualified as a depository for federal taxes. Use a federal tax deposit form with your payment. Many states have similar tax withholding forms.
A small business employer must deposit payroll taxes either monthly or quarterly, depending on the size of the payroll.
All employers must also send the IRS:
- Form 941, Employer’s Quarterly Federal Tax Return
This form must be filed every three months as long as your business has employees. Form 941 reports the amount of your employees’ federal income tax and FICA withheld for the previous quarter. - Form 940, Employer’s Annual Federal Unemployment Tax Return, or FUTA
Form 940 is filed once a year. On it, you report your total quarterly payroll tax deposit. On this amount, a federal unemployment tax is calculated. The FUTA tax is paid by the business and is not withheld from its employees’ paychecks.
According to the IRS, most businesses are delinquent in filing or paying employment taxes at one time or another. The IRS considers payroll taxes the most serious of all tax debts. The theory of the payroll tax law is that the employer acts as a collector for the government, holding its workers’ taxes in trust until paid over to the IRS. Consequently, the IRS views operating a business while owing payroll taxes as illegally borrowing money from the U.S. Treasury.
The Dreaded Trust Fund Recovery Penalty
A Common Scenario
Here’s a familiar scenario: Your small business is struggling. You pay the rent and your employees’ wages, but not the payroll taxes. You know things will turn around next month, however, when the big order comes in. And Christmas is just around the corner; you are sure you’ll pull out of the slump and be able to pay Uncle Sam in full.
Six months go by. Your sales have gone down. Orders stopped coming in and holiday sales were terrible. Your suppliers have sued you and your landlord is threatening to evict. You haven’t filed payroll tax forms or deposited payroll taxes for the last four quarters. You shut down and sell your assets to pay off the creditors, although you don’t pay the IRS the payroll taxes you owe. You manage to avoid bankruptcy by the skin of your nose.
If you did it this way, woe unto you. You should have paid the IRS first and then, if need be, filed for bankruptcy to handle private creditors. This is because the IRS is the creditor to be most feared.
What Happens Next
When payroll taxes haven’t been paid, the IRS can review a company’s books, speak to employees, and then hold its owners, managers, and bookkeepers personally responsible for the payroll taxes due. The IRS transfers the business payroll tax obligation to individuals, penalizing them for the business’s failure to make the payroll tax deposits.
This is known as the Trust Fund Recovery Penalty (TFRP). It applies primarily to incorporated businesses. If your small business was an LLC, a partnership, or a sole proprietorship, you can be found directly responsible for payroll taxes without the TFRP provision.
Because the penalty equals the taxes owed, it’s also called the 100% Payroll Penalty. (Internal Revenue Code § 6672.) And although in most instances the TFRP is transferred to employees of a defunct business, the IRS can, and will, impose the liability on people working for an ongoing business as well.
Legal Basis
The relevant section of Internal Revenue Code §6672 states:
Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable for a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.
Frequently Asked Questions
What are payroll taxes and who is responsible for paying them?
Payroll taxes are taxes withheld from an employee’s paycheck by an employer, which include federal and possibly state income taxes, as well as FICA (Social Security and Medicare) contributions. Employers are responsible for withholding these amounts and submitting both the employee and employer portions to the IRS and state tax agencies.
How often do employers have to deposit payroll taxes?
Employers are required to deposit payroll taxes either monthly or quarterly. The frequency depends on the size of the payroll. Larger payrolls may require more frequent deposits, as specified by IRS guidelines.
What forms must employers file with the IRS regarding payroll taxes?
Employers must file Form 941 (Employer’s Quarterly Federal Tax Return) every quarter and Form 940 (Employer’s Annual Federal Unemployment Tax Return) annually. These forms report income taxes, FICA, and federal unemployment taxes.
What is the Trust Fund Recovery Penalty (TFRP)?
The Trust Fund Recovery Penalty is a severe IRS enforcement action that holds individuals—including owners, managers, or bookkeepers—personally liable for unpaid payroll taxes. The penalty equals 100% of the unpaid taxes and is used when the IRS determines there was willful failure to remit trust fund taxes.
Can individuals be personally liable for unpaid payroll taxes if the business fails?
Yes, individuals involved in the management or financial oversight of a business may be held personally liable under the Trust Fund Recovery Penalty provisions, especially if the business is incorporated. For sole proprietorships and partnerships, personal liability is often direct and not limited to TFRP.