Payroll taxes may not be the most fun part of your business, but it’s a critical part. Any missteps, like inaccurate calculations, missed deadlines, and misclassified workers, can lead to penalties, interest, or avoidable audits, which can adversely affect your profits.

At 20/20 Tax Resolution, we’ve seen firsthand the damage that payroll problems can cause to a business. The great news? All of these can be avoided or corrected, and we are here to guide you through the payroll maze to ensure you stay compliant.

Key Takeaways

• Always file payroll returns even when you have “zero returns” to avoid penalties.
• Make sure to deposit the taxes as required based on your schedule.
• Address late payments or delinquent returns as soon as possible to minimize the risks.
• The IRS has the right to assess penalties against individuals responsible for collecting and remitting business taxes to recover unpaid payroll taxes.
• Payroll taxes are considered trust fund taxes and are viewed as the government’s funds once collected.

Common Payroll Tax Mistakes

Sometimes, even with an established payroll system, there’s a risk of making errors. Read on to see the potential payroll mistakes you’re likely to make to avoid them.

Missing Payroll Tax Deposits

The IRS requires employers to deposit the federal income tax withheld, together with the employer and employee portions of Medicare and Social Security.

Late deposit payments can attract penalties of 2-15% of the unpaid payroll tax, depending on how late your payment is. In addition to the penalties, you’ll also be charged interest on the unpaid payroll taxes from the date the amount is due until full payment is made.

It’s easy to avoid deposits when cash flow is strained, but doing so costs a lot in the long run.

To protect yourself, know your deposit schedule. If you’re a monthly depositor, your deposits are due by the 15th of the month following the month in which you paid wages. If you’re a semiweekly depositor, deposits for wages paid Wednesday through Friday are due by the following Wednesday, while deposits for wages paid Saturday through Tuesday are due by that Friday.

Not Filing Form 941 or 940

Employers are required to file Form 941 ( quarterly payroll taxes) and Form 940 (annual FUTA taxes).

Failure to file attracts a penalty of 5% per month, or for the part of the month your payroll tax return was late. It keeps accruing to a cap of 25%. Besides the penalties, the IRS sees not filing a return as a compliance issue, which can easily trigger an audit. Whether you have funds to pay for taxes or not, or you have “zero returns,” always file your returns.

Besides the penalties, the IRS can file an SFR, which may overstate your liability. To stay compliant, ensure you understand the Form 941 requirements.

Misclassifying Workers

Misclassifying employees is one of the most significant payroll tax mistakes. If you categorize an employee as an independent contractor, you may face penalties and back taxes if the IRS finds out.

As an employer, you must withhold income tax, Medicare taxes, and Social Security taxes from employees’ paychecks, and you must make a matching payment for the Social Security and Medicare taxes. Employers are also responsible for their employees’ unemployment taxes.

In contrast, independent contractors are responsible for their own tax obligations. Misclassifying an employee as an independent contractor can result in penalties for failure to withhold taxes, liability for unpaid employment taxes, and interest on overdue taxes. It can also trigger audits, resulting in increased scrutiny of your business.

“Borrowing” Withheld Payroll Taxes for Business Expenses

It’s not uncommon for business owners to feel tempted to use withheld payroll taxes, thinking they’ll refund them and remit them in time. It all falls apart when things don’t go as predicted and you’re unable to cover the “borrowed” funds when it’s time to pay the taxes to the federal government.

Why is this a problem? Any individual in a company that’s responsible for collecting and remitting payroll taxes is considered a trustee for the US government. The payroll taxes withheld are referred to as “trust fund taxes.” It means this isn’t your money; it belongs to the government.

When payroll taxes are misused, the IRS can assess the Trust Fund Recovery Penalty (TFRP). The civil penalty may be personally assessed against the person(s) responsible for collecting and accounting for paying taxes, but who willfully fail to do so. Once the penalty is assessed, the IRS can go after the individual’s personal assets.

Under-Withholding Federal Taxes

Withholding too little federal income tax from employees’ paychecks can lead to payroll tax compliance issues as well. Several reasons contribute to this, including outdated W-4 forms or missing paperwork for a new hire.

Another common reason is neglecting to report other forms of compensation. Besides regular wages, different forms of additional earnings, such as bonuses and commissions, are also considered taxable income.

Failing to account for additional earnings can lead to underpayment of taxes, which could result in penalties and interest charges for both you and your employee.

Not Meeting Tax Compliance Obligations Before Exiting

If you decide to step away from your business, it’s important you take care of your tax obligations.

First, it’s important to ensure you withhold and remit all required employment taxes. Even on final payouts, you’re required to uphold standard tax withholdings according to the IRS guidelines. Otherwise, the IRS will follow up to collect the tax liability, and the closure won’t erase the TFRP.

You also have to close your payroll reporting duties by checking the box that indicates final return on the Form 941 or Form 944. Both forms should reflect accurate totals up to the date your business operations cease. Ensure you indicate when the business has closed.

Failure to indicate that you were filing the final payroll tax report leads the IRS to think your business is still active. They, therefore, keep your account open and expect new Form 941s and annual Form 940s. When you don’t report, it automatically generates non-filing notices.

Ignoring IRS Letters or Penalty Notices

When you’re late with your payroll tax deposits or something isn’t right in your reporting, the IRS sends you notices and letters before it takes collection actions. All these letters serve a different purpose, and responding to them can provide an opportunity to rectify the situation and prevent escalation with the IRS. Here are examples of some letters and why you receive them:

• CP259: The IRS sends you this notice if they’ve not received your Form 941 or 940. If you don’t respond, the IRS can file a Substitute for Return (SFR), which can inflate your liability.

• CP276B: You receive this notice when your deposits are late, missed, or there are discrepancies in your filing. This provides you with an opportunity to explain and request a penalty abatement if you qualify, potentially reducing or waiving the penalty. If you ignore it, the penalties and interest continue.

• Letter 1153: You receive this letter if the IRS considers you a responsible person. Not responding in 60 days finalizes the TFRP, and the IRS now has the right to pursue your assets.

• CP504: You receive this notice just before the IRS starts seizing your assets. Ignoring it denies you a chance to make an agreement with the IRS to stop the levy. The IRS must send one more notice after this before seizing assets.

What to Do After Making a Payroll Tax Mistake

If you’ve realized you’ve made a payroll tax mistake, the key is to avoid panicking or ignoring it and explore your options at whatever stage you’re in. Acting fast can help control damage by preventing penalties, personal liability, and levies.

Here are some tips:

• Get organized: The first step is to identify what you owe and your current status with your payroll taxes. Gather all your documents, including the IRS notices, recent payroll filings, payment histories, and bank records. This will help you know when you went off track.

• Get your numbers right: The next step is to know how much your tax liability is, what penalties are still accruing, or whether the trust fund portion is at issue. If you’re not able to figure this out by yourself, consult a tax professional. Knowing your numbers will influence how you settle your tax debt.

• Correct the error if you catch it early: For example, if you accidentally underreported taxable wages on a past Form 94,1, you can amend the return using Form 941-X. You can also amend Form 940 using Form 940 and add the year of the tax return you’re amending.

• Respond to the revenue officers: Ignoring your IRS notices doesn’t buy you time; it actually works against you. Responding can actually help stop enforcement, such as liens or levies.

• Find a way to settle your tax debt: If you owe tax and can’t make payments without experiencing financial hardships, talk to a tax lawyer about payment plans. You can apply for an Offer in Compromise and pay less than you owe, set up a payment plan and pay monthly, or have your account on Currently Not Collectible to pause collections temporarily.

• Get professional help: A tax expert can help you determine what your next step should be to save you time and resources when dealing with payroll taxes.

How 20/20 Tax Resolution Can Help

Facing the threat of personal liability or payroll tax debt can be very overwhelming, but you don’t have to deal with it alone. At 20/20 Tax Resolution, we focus on tax resolution, including Trust Fund Recovery Penalty Resolutions and payroll tax cases.

Here’s what we bring to the table:

• Legal expertise and experience: Our dedicated team of tax experts is trained to work with the IRS. They’ve helped business owners in all kinds of industries and business sizes with this same issue.

• Customized strategies: One thing we’ve learned from dealing with multiple clients is that just because it’s a payroll tax issue doesn’t mean the solution is the same. We dig into the details of the actual facts of your case and provide you with solutions that align with your financial goals.

• A safe space: Everything you share with us is confidential, and we help with no judgment. All we ask is that you be honest about all your case details, however uncomfortable, so we can offer the support you need.

• We handle the IRS on your behalf: Once you start working with us, you won’t need to follow up with the IRS. We handle all the negotiations and communication on your behalf to ensure your rights as a taxpayer are protected.

Our clients share the same feelings of distress and uncertainty you’re feeling in the first meeting. But even after the first consultation meeting, they leave with less pressure and a way forward. We can do the same for you. We also offer payroll services.

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Frequently Asked Questions (FAQs)

Can the IRS shut down my business for unpaid payroll taxes?

Yes. If you have unpaid tax debt, the IRS can seize your business assets, freeze bank accounts, and effectively force a shutdown to collect the taxes owed. However, negotiating with the IRS can prevent this from happening.

What triggers a payroll tax audit?

There are many reasons that can cause the IRS to audit your returns – and sometimes, returns are selected randomly. However, red flags such as underreporting wages, discrepancies in payroll, and failing to file tax returns multiple times can increase the chances of being audited.

How can I resolve payroll tax penalties and interest?

You can have your penalties reduced or eliminated if you failed to return with a reasonable cause, such as a natural disaster. Consult a tax professional if you’re unsure whether you qualify.

Let’s Put Your Payroll Tax Issues to Rest

Falling behind on your payroll taxes doesn’t have to consume you or your business, but it can if you ignore it. The IRS won’t forget and move on; they’ll continue escalating the issues until you address them.

At 2020 Tax Resolution, we are ready to assist with any payroll tax controversy, audit, or penalty. Our experienced tax professionals will guide you through any payroll tax issue you have, protect your business, and help you regain tax law compliance.

Don’t let payroll tax liability threaten your livelihood. Contact 2020 Tax Resolution today and schedule a confidential consultation to discover how we can help you.