If your business has employees—including yourself—there are employment tax obligations imposed on the company (the “employer”) by the federal government. There are also state and local employment tax rules, such as paying unemployment taxes. The failure to follow the rules can result in penalties for the company, or even for you, personally, as the owner. The following are some problems related to federal employment taxes…and what you can or should do about them.
Problem 1: Misclassifying workers to avoid employment taxes
If workers are independent contractors, there are no employment tax responsibilities on the company. This is a substantial cost savings for a business. But simply labeling workers as ICs when they’re really employees is just wrong and can result in substantial penalties if the IRS reclassifies them.
Understand the IRS rules for worker classification. If the IRS reclassifies workers, see whether you qualify for Sec. 530 relief so you won’t be penalized (Sec. 530 is from the Revenue Act of 1978 which recreated the relief).
Problem 2: Making late deposits of employment taxes
Employers (other than very small employers with an annual liability for income tax withholding and FICA of $1,000 or less) are on a schedule to deposit taxes with the U.S. Treasury. If they don’t, there’s a penalty, the amount of which depends on how late the deposit is. If done no later than 5 days beyond the designated deposit date, the penalty is 2% of the unpaid amount. For 6-15 days, it’s 5% of the unpaid deposit. It becomes 10% for more than 15 calendar days. And there’s interest on top of that.
If you handle payroll in-house, create business practices to ensure timely deposits and avoid penalties. If dealing with employment taxes in-house is too much, use an outside payroll company, such as ADP or Paychex, or get help from your CPA or tax adviser.
Problem 3: Failing to deposit employment taxes
Being late is one thing; never making a deposit is quite another. Withheld income tax and the employees’ share of FICA are called trust fund taxes because the employer is merely managing them on the employees’ behalf. Employers facing financial difficulties may have trouble depositing their employment taxes. If there is a willful failure to make the deposits, a responsible person may be 100% liable for the undeposited tax. This 100% penalty is called the trust fund recovery penalty.
- What’s willful? This results when a responsible person is aware of outstanding trust fund taxes but fails to make the deposits. It’s not necessary that there be any evil intent or bad motive. It can merely be choosing to pay the rent ahead of depositing the trust fund taxes.
- Who’s a responsible person? This is an owner, officer, or employee who has the duty and power to collect and pay trust fund taxes.
Set aside funds to pay employment taxes and prioritize trust fund tax deposits over other obligations. Owners who do not directly make the deposits should monitor that they are being made. Familiarize yourself with the information in Notice 784, Could You Be Personally Liable for Certain Unpaid Federal Taxes?
Problem 4: Mishandling refunds of overpaid employment taxes
When an employer overpays employment taxes, a refund is possible. But it has to be done correctly or the refund won’t be issued.
The IRS says that the employer must repay or reimburse the employees’ portion of FICA to the employees or get their consent to the allowance of the claim for refund. When using the consent option, it must accompany the refund request. The rules for properly handing refunds of overpaid employment taxes are in Rev. Proc. 2017-28.
There were almost 54,000 employment tax audits closed in the government’s 2022 fiscal year ending September 30, 2022. More than half of these were field audits—at employers’ businesses or IRS offices. To avoid paying penalties, or even worse, becoming an audit statistic, carefully monitor your employment tax policies and procedures.
You’ll find more blogs regarding employment taxes published here.