When cash gets tight, payroll taxes are the money that is easiest to borrow from and the most dangerous to leave unpaid. Owners often do it intending to catch up, and the IRS does not treat that as a small matter.
Why payroll taxes are different
Money withheld from employees' paychecks for income tax, plus the employee share of Social Security and Medicare, is called trust fund tax. The business holds it for the government. Using it for other expenses is treated far more seriously than an ordinary tax balance.
Penalties that can apply
- Failure-to-deposit penalty, which increases with how late the deposit is. The rates are tiered, starting at 2% for deposits a few days late and rising to 15% in the most serious cases.
- Failure-to-file penalty for late Forms 941 and 940.
- Failure-to-pay penalty and interest on unpaid balances.
- Trust Fund Recovery Penalty, described below.
The Trust Fund Recovery Penalty
Under Internal Revenue Code section 6672, the IRS can assess a penalty equal to the unpaid trust fund taxes against individuals who were responsible for collecting and paying them and who willfully failed to do so. Responsible persons can include owners, officers, and others with authority over finances. Because it is assessed against individuals, forming an LLC or corporation does not necessarily protect you from it.
Willful failure to collect or pay over payroll taxes can also carry criminal exposure. If you are in a serious situation, speak to a tax attorney or other qualified representative.
What the IRS may do
- Send notices and balance-due demands.
- File a federal tax lien against business assets.
- Levy bank accounts and receivables.
- Assess the Trust Fund Recovery Penalty against responsible individuals.
Steps to get back on track
- 1Stop the bleeding: make current-period deposits on time, even if prior balances remain.
- 2Identify exactly which quarters are unfiled or unpaid, using IRS notices and records.
- 3File all missing Forms 941 and 940, and W-2s if needed.
- 4Reconcile payroll records to the books so the filings are accurate.
- 5Contact the IRS to discuss a payment arrangement. See IRS payment plans for small business owners.
- 6Request penalty relief where it applies. See IRS penalty abatement.
- 7Outsource payroll or add controls so it does not recur.
Don't forget state obligations
State withholding and unemployment taxes are separate from federal filings, with their own penalties and enforcement. A business behind federally is often behind with a state agency too.
If you received a notice, see IRS Notice CP504. Our IRS resolution service can review your situation, and our payroll service can keep you current going forward. When you are ready, get help with your business tax situation. Outcomes depend on your facts.
