The phrase "making payroll" is commonly heard in the small business world. It essentially means managing a small business so that paychecks are delivered to employees on time, even when the unexpected occurs.In many cases, payroll can be one of the most difficult duties on a small business owner’s to-do list. One thing certain to make this task even harder is a payroll tax mistake that can lead to major, undesirable problems with the IRS.
The IRS is not very receptive to excuses when it comes to timely payment of payroll taxes, and neither are state tax authorities in the 41 states that have state income tax withholding rules.
When a cash crisis occurs, it can be tempting to “borrow” money withheld from employee paychecks as a short-term solution for urgent expenses. But try not to give into this temptation. The IRS views this as a cardinal sin, and it can result in both civil and criminal penalties that are difficult for any small business owner to get past.
Here are 5 things that all small business owners should know about payroll taxes to avoid potential IRS problems:
1) Penalties Can Add Up Quickly
A small business can find itself facing a mountain of debt that can result in a total shut-down of operations if payroll tax penalties are allowed to build up over time. It doesn’t take long for any of the three major payroll tax penalties from the IRS to add up. These include:
ØFailure to file
ØFailure to deposit
ØFailure to pay
The penalty for any of these three can be as much as 33% of the total amount owed, plus interest.
2) Timely Deposits Are Critical
Payroll taxes must be paid to the IRS within three days of the payroll check date. In most cases, you must deposit federal income tax withheld and both the employer and employee Social Security and Medicare taxes using an electronic funds transfer through a payroll service or through your bank.Late fees and penalties begin accruing on the due date. There is no grace period.
3) Small Business Owners Are Personally Liable
The Trust Fund Recovery Penalty (TFRP) gives the IRS the power to go after small business owners individually for payroll taxes owed. There is no corporate layer of protection that the IRS cannot surmount if they decide to use TFRP. The decision to use it is at the discretion of the IRS.
This penalty is equal to the income taxes, Social Security taxes, and Medicare taxes withheld from employee paychecks. The penalty is authorized by Section 6672 of the Internal Revenue Code.
4) The IRS Keeps A Close Eye On Small Businesses
Small businesses represent the largest source of uncollected taxes, so the IRS carefully watches small business owners with a keen eye. This is true all the time, but special attention is often paid to small businesses during down economic cycles, within the first two years after an employer identification number (EIN) is requested by startups, and when a small business hires seasonal employees or has a flexible workforce that grows and contracts out.
5) You Could Face Criminal Penalties
Some small business owners get into trouble with the IRS because they think that a micro-business that has one or two part-time employees is too insignificant to show up on the IRS radar. Don’t buy into this, though. The threshold for referral to the criminal investigation division is very low.
Whether you’re on the hook for just a few dollars or thousands of dollars, the Department of Justice only has to prove that you intentionally did not file or pay what you owed. As soon as an investigation begins, the IRS can freeze your bank accounts, making it nearly impossible for most companies to even stay open.
As part of an investigation, the IRS can get bank statements, bank signature cards, and cancelled checks directly from your bank. In all likelihood, you probably won’t even know that the bank has received a summons to turn the records over until after they have been given to the IRS.
With this bank information, the IRS will try to decide who had the authority to direct tax withholding to other purposes instead of paying the IRS. This means anyone with signature authority on checking accounts or bank debit cards may find themselves part of the investigation. If the IRS is considering exercising the Trust Fund Recovery Fund Penalty clause in the IRS Code, each and every individual may have their personal bank accounts frozen during the investigation.
How To Avoid Payroll Tax Problems
It’s really easy to avoid payroll tax problems. Just pay every penny owed to the IRS on time. A payroll service and tax partner with the experience and integrity to keep the IRS away from your door can help any business avoid payroll tax problems.
Brendon Pack is a Vice President of 1800Accountant, a national accounting and business consulting firm based in New York. The company offers a wide range of accounting, tax, bookkeeping, payroll, and business support services to new and established small business owners as well as individuals.