The average person doesn’t think about payroll taxes as they would income tax or sales tax. Business owners know the importance and impact it has on their business and possibly on their personal tax situation.
Payroll taxes are a major reason businesses and their owners fall into serious tax issues. Many times, businesses find that a cash flow problem exists, and payroll taxes is a place where they can get temporary help. But this often results in the snowball effect of a growing, out of control payroll tax liability. What appears to be a possible solution, can end up being a major trap with heavy tax consequences.
When business slows down, it’s tempting to use the money set aside for payroll taxes to cover other costs. The thought is that business will pick back up next month and there will be sufficient funds to catch up on taxes. However, the business doesn’t improve, and the cycle continues, with penalties and interest being added to the debt.
If the business does not pay, the owner or other officers may personally bear responsibility. With severe liabilities, this could destroy personal finances. This occurs far too often.
Businesses collect and pay income tax and FICA taxes to the government based on their payroll size. Two taxes make up the FICA. One is a 6.2% tax for Social Security and the other is a 1.45% tax for Medicare. The employer also contributes the same amount for both taxes.
The money deducted from employees’ paychecks for income taxes and FICA is referred to as “Trust Funds.” This money is held by the employer in trust for the U.S. Government and is a protected source of revenue. IRC §6672 lets the IRS penalize individuals and/or businesses who willfully do not pay the payroll taxes.
This penalty applies to individuals responsible for collecting, accounting for, and paying payroll taxes, and is imposed on those who willfully fail to fulfill this duty or attempt to evade tax payment.
This penalty is the Trust Fund Recovery Penalty (TRFP), and there are two key elements required for IRC §6672 TFRP:
- The individual had to collect, account for, and pay over the payroll taxes.
- The person must have willfully neglected to do so.
Willfulness Requirement
For IRC §6672 the failure to account for and pay over the payroll taxes must have been a willful action. According to Revenue Ruling 54-158, the IRS takes the stance that willfulness is present where “money withheld from employees as taxes, in lieu of being paid over to the Government, was knowingly and intentionally used to pay the operating expenses of the business, or for other purposes.”
Stating that there were not enough funds to cover both the employee expenses and the payroll tax is not a defense. Employers would be expected to pay employees a prorated amount that would allow for the full payroll taxes to be paid. When employees are not paid their full amount for a full day of work, businesses face a significant problem. This is because such employees may choose to leave the company.
100% Penalty
The Trust Fund Recovery Penalty is a 100% penalty, which sounds extreme. But the original amount does not have 100% of the payroll tax added to it. This means that the IRS policy is to collect 100% of the payroll taxes that the business did not pay. The penalty is that the IRS comes after the individual on their personal account.
This means that the business and the individuals will be making payments on the same original amount. The IRS now increases the chances that they can collect payment of payroll taxes. Unfortunately for the individual, they could have issues with their personal finances.
Collection Statute
Upon assessment of the taxes, the IRS has ten years to collect the tax. If there is no payment activity for a while, the IRS make an assessment for the TFRP. This assessment is called the 6672 Civil Penalty. This starts a new ten-year collection statute for the parties assessed.
The statute will run until either it the statute expires or the Trust Fund taxes are collected. This is true even if the statute for the company expires. The individual taxpayer will cover the company’s shortfall in paying the taxes.
Another thing to consider for the statute is that there are events that will toll or stop the statute from running. The IRS will add the time it takes for the events to take place to the statute. Here are some events that will toll the statute:
- Filing for a Collection Due Process (CDP) Hearing
- Requesting an Installment Agreement(I/A)
- Request for Innocent Spouse Relief
- Submitting an Offer in Compromise (OIC)
- Living outside the U.S. for 6 months or more
Who is a Responsible Person
In many business operations, there may be a number of persons who could be held responsible. A person’s title doesn’t automatically make that person responsible. A high-ranking officer who has nothing to do with finances may not be responsible for the payroll taxes.
The president who has put in place a finance staff to manage the payroll taxes, may be functionally responsible. As president, that person is responsible for the oversight of the entire company.
There could be a staff accountant who has the authority to pay taxes and also make payments to other creditors. This lower-level employee would be functionally responsible for willfully not paying the taxes. Any employee involved in the finances of the company and who can decide on which creditors to pay may be held responsible for the unpaid taxes.
Here is a list of usual employees that would be considered responsible:
- Sole Proprietors
- Partners
- Bookkeepers
- Lenders/Creditors
- Accounting Firms
Taxpayers must know their financial duty as a business owner, officer, or employee regarding payroll taxes. Failure to pay the payroll taxes could result in a personal liability from an IRS civil penalty. This leads to dealing with collections and possible filing of liens and levies on personal property assets. It can cause great personal financial stress and pain when the payroll taxes of a business are not paid.
For more information on Payroll Taxes, feel free to contact Dan Ohara at (408) 684-8505 or email at dan@oharataxresolution.com.