IRS Failure-to-Deposit Penalty: How to Avoid 941 Tax Deposit Penalties

Employers have an obligation to withhold and deposit Social Security taxes, Medicaid taxes, and income taxes from their employees’ paychecks. They must also make matching payments for Social Security and Medicare payments. Every employer has a schedule that outlines when they must deposit these payroll taxes. Failing to adhere to this schedule, either knowingly or unknowingly, can lead to hefty penalties.

The failure to deposit penalty is charged for deposits that are not made in the right way, in the right amount, or on time. Because these deposits are often quite large, the penalties can add up quickly, causing significant financial distress for businesses.

Key takeaways:

• Businesses must deposit payroll taxes on a semiweekly or monthly basis.
• The failure to deposit penalty ranges from 2% to 15% of the past due amount.
• Penalty abatement is an option for some businesses.
• Planning and automation of payroll tax deposits can help you avoid penalties.

What is the Failure to Deposit Penalty?

The failure-to-deposit penalty is assessed when a company does not deposit employment taxes correctly. Each deposit must include all accrued income taxes, Social Security taxes, Medicare taxes, and federal unemployment taxes. The penalty is a percentage of the amount that was underpaid, paid late, or paid in the wrong way.

Depending on the business, they may be required to make monthly or semi-weekly payments. However, if a business accrues more than $100,000 in payroll taxes, they must make a deposit by the next business day.

The Internal Revenue Code (IRC) and Treasury regulations give the IRS authority to charge failure to deposit penalties. This authority is granted under IRC 6656, which outlines what may happen when a business fails to deposit taxes.

Understanding Form 941 and Deposit Requirements

Form 941, Employer’s Quarterly Federal Tax Return, is used to report income taxes, Social Security taxes, and Medicare taxes. This is where you record all required deposits made during the quarter for which you are filing. Part 2 of the form covers the business’s deposit schedule and tax liability.

Deposit Schedules and Frequency

A failure to understand your company’s deposit frequency and schedule is a common reason for the failure to deposit penalty.

There are two deposit schedules for employment taxes: monthly and semi-weekly. Your deposit schedule is determined before the start of each calendar year, based on a four-quarter lookback period. If you have $50,000 or less in taxes during the lookback period, you deposit monthly. If you report more than $50,000 in the lookback period, you must deposit on a semiweekly schedule.

The monthly deposit schedule requires that employment taxes collected during a month must be deposited by the 15th of the following month. Companies with a semiweekly deposit schedule deposit taxes for payments made on Wednesday, Thursday, and Friday by the next Wednesday. Deposits for payments made on Saturday, Sunday, Monday, and Tuesday must be made by the next Friday.

As noted above, if a depositor accrues $100,000 or more in taxes on any one day, those taxes must be deposited by the next business day.

Exceptions to the Deposit Rule

The IRS offers some employers the ability to pay their payroll taxes without making deposits.

If you file annually using Form 944 instead of quarterly with Form 941, you can send your payment with your annual return as long as your annual payroll taxes are less than $2500. If you’re a 941 annual filer who makes quarterly deposits, you can send the fourth quarter payment with the 944 form, as long as that quarter’s liability is less than $2500 and you’ve made deposits during the other three quarters.

Similarly, businesses that file Form 941 and owe less than $2500 in payroll tax for the quarter may also skip the deposits and mail a payment or pay online when they file their quarterly report.

Penalty Rates and Calculations

The penalty rate depends on how late you are with your payment. If your payment was not late but was the incorrect amount or made in the incorrect method, it is considered late until the error is fixed.

Penalties are tiered; the longer you are delinquent on your employment taxes, the more severe the penalty is:

• 1-5 calendar days: 2% of the unpaid deposit
• 6-15 calendar days: 5% of the unpaid deposit
• 15+ calendar days: 10% of the unpaid deposit
• More than 10 calendar days after receiving an IRS notice or the day you get a notice demanding immediate payment: 15% of the unpaid deposit

How to Calculate Payroll Deposit Penalties

Imagine you were supposed to make a $3000 deposit on the 15th of the month. You failed to make that payment and let it go unpaid until the 22nd. At that point, you are within the 6-15 calendar day range, so your penalty is 5%. In addition to paying the $3,000, you must pay a $150 penalty. The penalty will accrue interest at the current quarterly rate, compounding daily until paid off.

This can snowball quickly if you owe a substantial amount and let your taxes go extremely delinquent. Assume your $15,000 tax deposit was due on a Friday. You fail to make the deposit and ignore it until the IRS sends you a first notice requesting payment. Your penalty is now 15%, resulting in a total amount due of $17,250. Again, interest will accrue on the debt and the penalty.

Common Causes of Late Payroll Tax Deposits

If payroll tax deposits are so important for a company, why are late deposits so common? How does this happen? A number of common errors can result in late or inaccurate deposits.

Cash Flow Issues

Unfortunately, this is a huge warning sign for a business. If a company has cash flow issues significant enough that they begin borrowing from their employment taxes, something must change immediately or the business may very well be on its last legs.

What often happens is that a business owner borrows from collected employment taxes to cover urgent costs, planning on paying back the taxes when more money comes in. However, the issue originally leading to the urgent need for money is never resolved—so not only is the business owner unable to pay back the original taxes, they have to continue borrowing from deposits to keep their head above water.

Administrative Oversights

Administrative oversights are relatively common, especially businesses going through significant periods of growth. As a business owner’s responsibility grows with additional employees, clients, and expenses, routine administrative work may get bumped to the bottom of the to-do list. This issue is commonly resolved after the first penalty, as the business owner realizes the true cost of failing to make timely deposits.

Misunderstanding Deposit Schedules

Your deposit schedule is based on a lookback period of the previous four quarters. If a business owner misunderstands their accrued taxes for that lookback period or completely misunderstands the lookback period, they may follow the wrong deposit schedule and subsequently miss important deposits. This, too, is a fairly easy fix—and as long as a business catches the error early, they can avoid subsequent penalties.

Consequences of Non-Compliance

The penalties of failing to comply with deposit requirements are heavy, affecting everything from your financial stability and well-being to your reputation as a business.

Financial Impact

Businesses of all sizes can be heavily financially affected by payroll tax penalties. When you owe as much as 15% on a deposit that’s worth thousands of dollars, it can significantly eat into operating costs and profits. The impact is particularly devastating for businesses that run on a tight profit margin or are struggling to get established. When there’s very little wiggle room for error, even one penalty can throw your entire financial plan into disarray.

Legal Repercussions

The legal fallout can be painful for your business. The IRS’s scrutiny on business taxes can mean that you have to be on high alert until you get caught up and get into a pattern of compliance with IRS requirements. If the IRS notices discrepancies or errors in your deposits, your business could be audited—and that would drastically increase your legal and accounting expenses as you prepare.

Reputational Damage

Businesses have to report their finances to their board of directors. Even in businesses that are just owned by a small group of partners, tax issues can have a strong negative impact on your reputation. Imagine having to tell shareholders that your profit margins are lower than anticipated because of a preventable tax error that cost you 10% on a deposit—such a simple error could rattle shareholders’ faith in the business as a whole.

If one partner is responsible for tax issues and deposits, this type of error can weaken the business relationship between partners and lead to strife between business owners.

Additional Penalties and Collection Actions

If you continue to ignore your payroll taxes, the IRS may start involuntary collections to obtain the funds. The agency can seize business assets, intercept payments from clients to you, garnish your credit card processing system, or take other actions to collect the debt.

Eventually, the agency may levy the Trust Fund Recovery Penalty against individuals responsible for the unpaid taxes – owners, shareholders, and even employees or third-party payroll companies. If the IRS plans to assess this penalty against you, they will send Letter 1153. Once a TFRP has been assessed against an individual, the IRS can go after their individual assets and wages.

Strategies to Avoid Failure to Deposit Penalties

Although a failure to deposit penalty can have a significant negative impact on your business, these penalties can be avoided with the right preparation.

Robust Payroll Systems

Automating as much of your payroll as possible can help you avoid unnecessary delays in your tax deposits. Ideally, you’ll pair an automated payroll system with a strong network of financial accounts that keep employment taxes completely separate from funds used for business operations and other expenses. With this type of setup, it’s just a matter of double-checking that deposits have been made on time, versus trying to do it manually semiweekly or monthly.

Regular Compliance Audits

If you don’t realize that you’ve fallen behind or made an error until the IRS reaches out, you aren’t auditing your systems often enough. Periodic reviews of your tax protocols and procedures, as well as verification of timely and accurate deposits, can help you catch problems before they cost you money.

Proper Employee Hiring and Training

This is often the solution for companies that are going through a period of growth. For a smaller company, having one person do human resources, employee management, and tax deposits may make sense—but when a company starts growing, having one person take on multiple roles rapidly increases the likelihood of a mistake. If your company has grown and your staff hasn’t increased to account for the larger work volume, it may be time to bring in a professional to handle payroll and tax deposits.

Steps to Take If You Receive a Penalty Notice

You’ve received a notice indicating that the IRS is charging you a penalty—what now? Follow these steps to protect your business’s financial stability and tax compliance.

• Review the notice. Read the notice carefully to figure out why you’ve been penalized and the amount the IRS is charging you. Check it against your own records for accuracy.
• Respond to the IRS or contact a tax professional. You’ll want to take action right away on this issue since the penalty increases every few days.
• Look into payment options. Reach out to the IRS to set up payment or discuss your options.
• Consider reaching out to a tax professional. You can also connect with a tax pro—as a business owner, having an experienced pro in this area can help you respond to issues quickly.
• Consider penalty abatement. You may qualify for first-time or reasonable cause penalty abatement. First-time penalty abatement is generally available to those who have a history of tax compliance and no history of penalties. Reasonable cause penalty abatement gives you relief from penalties if you have a good reason for failing to deposit on time.

You may also receive Letter 5857 about your failure to make payroll deposits. This letter doesn’t focus on penalties – instead, it requests that you contact the IRS so they can talk with you about their concerns.

Importance of Professional Assistance

Tax regulations for business owners can be incredibly complex, and it’s normal for business owners to get overwhelmed or misled when trying to understand their obligations. When you work with a licensed tax professional, you can get personalized assistance with penalties, unpaid taxes, unfiled tax returns, and general tax compliance. When choosing a pro, make sure to look for someone who has experience with payroll taxes and resolution in particular.

At 20/20 Tax Resolution, we strive to help businesses stay compliant with IRS regulations to avoid penalties. When you choose our firm, we can help verify the accuracy of the penalty. We can also work with you to request penalty abatement and other forms of relief.

Looking ahead to the future, our firm will help you understand how to set up protocols and procedures that prevent further tax issues.

Making timely and accurate payroll tax deposits is a critical part of setting your business up for success. Failing to comply with this requirement could result in penalties as high as 15% of the past due amount, delivering a significant financial blow to your business.

While a failure to deposit penalty can be a setback to your business, it isn’t insurmountable. With penalty abatement and payment options, you may be able to limit the financial fallout. Careful planning, automated payroll systems, and regular audits of your tax procedures can help you stay compliant with IRS requirements and avoid penalties.

Find out how our team’s professional tax guidance and legal support can help you tackle this and other tax issues. Call us at 1-877-369-5420 or fill out our contact form to have a team member reach out to you.