A key responsibility of being an employer is handling payroll taxes. These are comprised of figuring income tax withholding from employees’ paychecks (federal and, where applicable state), as well as the employee’s share of FICA. It also means depositing this withholding plus the employer share of FICA. But various tax rule changes related to COVID-19 complicate employer actions with respect to employment tax deposits. The following explains the basic rules and then the modifications resulting from COVID-19-related legislation.
Trust fund recovery penalty
Employers hold a unique position when it comes to withholding taxes from employees’ paychecks. Employers are responsible for withholding income taxes and the employees’ share of Social Security and Medicare (FICA) taxes and timely depositing these funds with the government. Because these funds are employees’ tax payments, they’re referred to as trust fund taxes. Employers that fail to meet these responsibilities can be subject to a trust fund recovery penalty (TFRP). This is a “100% personal penalty” imposed on a “responsible person” who “willfully” fails to deposit trust fund taxes. The IRS makes a determination about the applicability of the penalty and can then assess it.
100% personal penalty
The penalty is equal to all of the income taxes withheld from employees’ paychecks that haven’t been deposited, plus all of the FICA taxes withheld from their paychecks. This is a civil penalty that can be assessed by the IRS unless a decision is appealed. Collection actions can include a federal tax lien, levy, or seizure against personal assets. Generally, an individual cannot avoid this penalty through bankruptcy; it’s not discharged.
Even if you’ve organized your business to avoid personal liability—you’ve incorporated or formed a limited liability company—you are personally liable for unpaid amounts if you’re a responsible person. Again, if the IRS finds you are liable for the penalty, your personal assets are at stake.
This is an individual or group of people who have the power to direct the payment of the funds. Usually, this is the person who writes the check (not literally because employment taxes must be deposited electronically); the person who disburses company money. It’s the person with check-signing authority who knows or should know what’s happening with the company’s finances. In small businesses, this is typically the business owner. Other examples of “responsible person” include:
- An officer or an employee of a corporation
- A member or employee of a partnership
- A corporate director or shareholder
If you use a payroll company, this does not automatically relieve you of responsibility for trust fund taxes. But the payroll service provider may be found to be the responsible person under the facts and circumstances of the situation. The same is true if an outside accountant has the authority to pay bills.
A responsible person acts willfully when he or she knows or should have been aware of outstanding trust fund taxes and intentionally ignores deposit obligations or is simply indifferent to them. There’s no requirement that the responsible person is evil or has a bad motive. Simply using funds to pay any other bills is enough to show willfulness. For example, a company is experiencing cash flow problems. Does it pay the rent? Does it pay for continued electricity and/or internet access? Does it pay suppliers for needed inventory? If it pays any of these bills instead of depositing the trust fund taxes, this is considered willfulness.
Potential criminal charges
Civil penalties are bad enough, but it can also be a federal felony for a responsible person to not deposit trust fund taxes. It’s punishable by up to 5 years in prison as well as monetary fines.
Business owners that use trust fund money to pay for a lavish lifestyle risk being charged with a crime, punishable by imprisonment and an order of restitution of funds. For example, in a recent case, an owner of multiple parcel delivery services had revenues of more than $100 million between 2002 and 2017. During this time, he failed to pay the government over $10.8 million withheld from employees’ paychecks. Instead, he spent the money to fund a lavish lifestyle, buying expensive cars, motorcycles, and jewelry, and getting plastic surgery. He plead guilty and was sentenced to serve 24 months in prison and three years of supervised release, as well as paying more than $9 million in restitution to the U.S. government (some of the money had already been repaid).
While the basic trust fund recovery penalty is unchanged, employers are allowed to use employees’ withholding to receive advance payment from the government for certain tax credits related to COVID-19. Keep in mind that these credits cannot be used by a business that obtained forgiveness for a Paycheck Protection Program loan and the basic rules described above apply.
Instead of depositing employees’ withholding (income taxes and FICA must still be withheld), an employer can apply this amount, as well as the employer’s share of FICA, to cover certain tax credits:
- Employee retention credit
- Credit for paid sick leave related to COVID-19
- Credit for paid family leave related to COVID-19
If payroll taxes exceed the credit amounts, they must be deposited under the usual rules. The application of withholding toward these credits is factored into Form 941, Employer’s Quarter Federal Tax Return.
Note that while employers have the option of deferring their share of Social Security taxes owed on taxable compensation from March 27, 2020, to December 31, 2020, this deferral option does not apply to the employers’ share of Medicare taxes nor to the employees’ share of all FICA).
Be sure to coordinate your tax deposits with deferral option and the COVID-19-related tax credits to which you are entitled. If you’re experiencing financial difficulties and fall behind in depositing trust fund taxes where required, take immediate action to get back on track. You may qualify for a business payment plan (or an individual payment plan if you’re a sole proprietor), allowing you to pay what’s owed, plus penalties and interest, over a period of time. Keep your priorities straight and take advantage of options to remain in compliance to avoid a trust fund recovery penalty.