Payroll Tax Penalties

Payroll Tax Penalties: Consequences of Unpaid Payroll Taxes

The consequences of not paying payroll taxes can range from small penalties for making a payroll deposit a day late to criminal penalties for not paying these taxes. Unpaid payroll tax penalties vary based on the situation, but it’s critical to note that the Internal Revenue Service takes these taxes very seriously. 

If you have unpaid employment taxes, you’re going to face consequences that are potentially much more severe than if you have unpaid federal income taxes. This guide explains what happens when you get behind on payroll taxes. Need help now? Then, contact us today. At the W Tax Group, we can help with all kinds of tax issues including back payroll taxes.

What Are Payroll Tax Penalties?

Payroll tax penalties are the penalties you pay when you pay these taxes late or not at all. They include late deposit penalties as well as the trust fund recovery penalty. Unpaid payroll tax penalties are based on the tax liability and can range from 2% of the taxes that were supposed to be deposited to 100% of the trust fund taxes. 

What Are Payroll Taxes?

Payroll taxes refer to the taxes that you withhold from your employees’ paychecks plus the matching amount that you need to pay. This includes the social security, Medicare, and federal income tax that you withhold from employee wages. On top of the withholding taxes, it includes the matching payment you need to make for social security and Medicare taxes plus your federal unemployment taxes. 

Payroll Tax Versus FICA Taxes

These payments are sometimes called FICA taxes. But FICA taxes aren’t exactly the same thing as payroll taxes. Short for the Federal Insurance Contributions Act, FICA taxes include Social Security and Medicare taxes. They don’t include income taxes withheld from employees wages.

Penalties for Late Payroll Tax Deposits

After you withhold income taxes and other FICA taxes from your employees’ paychecks, you need to make sure you pay them on time. Paying payroll taxes requires you to deposit taxes online or over the phone. You can’t pay payroll taxes through the mail.

Here are the penalties for making deposits for payroll tax payments late:

• 2% of the tax due if you’re one to five days late. 
• 5% of the tax due if you’re six to 15 days late.
• 10% of the tax due if you’re 16 days later or if you pay within 10 days after the first IRS notice for late a deposit has been issued. 
• 15% of the tax due if you pay 10 days or more after the IRS notice has been issued. 

For instance, if you’re supposed to make a $2,000 deposit, your penalty will be $40 if you are five or fewer days late. The penalty will be $300 if you make your deposit 10 or more days after the IRS sends the notice.

Trust Fund Recovery Penalty for Unpaid Payroll Taxes

Well, what happens if you don’t pay employment taxes at all? In this case, you may face the maximum penalty for a late deposit, and on top of that, you may face the trust fund recovery penalty for the unpaid taxes. This is one of the most severe penalties that the IRS imposes, and the only similar penalty is for tax fraud. 

The trust fund recovery penalty is 100% of the trust fund taxes that you owe. This doesn’t include all of the payroll taxes that you owe. Instead, it just includes the payroll taxes withheld from your employee’s paychecks. They don’t include the employer’s matching portion of the taxes, the federal unemployment tax, or the state unemployment tax. 

Trust fund taxes are actually taxes paid by your employee. Say for example, that your employee earns $1,000. You withhold $62 of Social Security tax, $14.50 in Medicare tax, and $100 in income tax, and you cut your employee a check for $823.50. Although you have to deposit the $176.50 that you withheld, your employee is the one who is actually paying that amount. 

That’s why these are called trust fund taxes. Your employee and the IRS are trusting you to pay these taxes on behalf of your employer. If you withhold the income tax and FICA taxes without paying them, you are essentially stealing from your employee and from the government. That’s why the penalty for not paying these payroll taxes is so severe. 

Who Is Responsible for Unpaid Payroll Taxes?

Generally, only the employer is responsible for their portion of the payroll taxes. However, employment tax laws allow the IRS to hold numerous people held responsible for unpaid trust fund taxes. The business owner, partners, and corporate officers can be held responsible for these taxes, but here’s the part that may surprise you — employees, third-party payers, and other responsible parties can also be held responsible for withheld employment taxes that weren’t paid. 

Basically, the IRS can assign responsibility to anyone who made the decision to not pay these taxes. Say that a small business bookkeeper decides to pay the electricity bill instead of making the payroll tax deposit. They may be responsible, and they IRS may want to interview them about the penalties.

However, responsibility depends on the details of the situation. Now imagine that the bookkeeper just writes checks and enters numbers into bookkeeping software. They don’t make any decisions about how the funds are allocated. Their boss directs them to pay the electric bill instead of the payroll taxes. In this case, the responsibility stays with the owner. 

Deposit Requirements for People With Unpaid Employment Taxes

If you remit payroll taxes late in a while, the IRS will usually just assess the late-deposit penalty. However, if you have a habitual problem of making late deposits or not paying payroll tax at all, the IRS may require you to make special deposits. 

In this case, you will receive Form 2841 (Notice to Make Special Deposits of Taxes). When you receive this notice, you must make all of your deposits within two days of the date that you withhold the taxes. If you don’t, you can face a $500 fine and up to a year in jail.

Consequences of Late State Payroll Taxes

In most cases, you will also need to withhold state taxes from your employee wages. This includes state income taxes. Then, when you pay taxes to the state, you pay the amount you withheld. You also have to pay state unemployment taxes.

How to Get Caught Up on Payroll Taxes

To get caught up on payroll taxes, first, make sure that you have filed all of your payroll tax returns. If you haven’t made any payments, these returns will show you how much you owe. Then, try to make a plan to pay the tax debt as quickly as possible. Here are some of the payment options. 

Pay in Full

If you can pay the unpaid tax in full, you can minimize the payroll tax penalties that apply to your account. Even if you don’t have the funds outright, you may want to use a credit card or borrow money to deal with the unpaid tax bill. Businesses can take creative routes to borrow money for unpaid employment taxes, such as taking out a loan against your unpaid accounts receivables. 

Set up a Payment Plan

The IRS is typically willing to let you set up a monthly payment plan on payroll taxes if you owe less than $25,000 and can pay off the balance in less than 24 months. If you owe more or need longer to pay, you’ll need to work directly with a revenue officer to set up payments. They may not be willing to work with you. For best results, you should hire a tax attorney to argue your case.

Request an Offer in Compromise for Payroll Taxes

This is when the IRS lets you settle your payroll taxes for less than you owe. Usually, the IRS will only settle the employer portion of the payroll taxes. They won’t settle the trust fund taxes. Those must be paid by one of the other responsible parties if you want to get a settlement on the rest of the balance.

The only exception is for cases of payroll provider fraud. If your payroll service provider didn’t pay the payroll taxes and you believed they were, the IRS will probably not assess the trust fund recovery penalty against you. 

With all of the resolution options to help you pay payroll taxes, you may have to meet specific criteria. For instance, you may not be able to set up a payment plan unless you stay current with all of the filing and deposit requirements while the plan is active. You may not be able to get an offer in compromise on your payroll taxes unless you close down your business. When you meet with a tax attorney, they will be able to tell you about the rules and processes for different resolution options. 

FAQs About Payroll Tax Penalties

Both employees and employers have lots of questions about these taxes. Here are some of the most frequently asked questions about payroll taxes and penalties.

What happens if employer doesn’t pay payroll taxes?

The IRS will assess payroll tax penalties against the employer. The IRS may require the employer to get on a special deposit schedule where they make deposits within two days of withholding the funds from their employees’ checks. 

What is the employer failure to withhold taxes penalty?

If the IRS decides that you have made a willful failure to pay tax, you may face felony charges, a $10,000 fine, and five years in prison. This is on top of any other payroll tax penalties that the IRS assesses.

What if my employer withheld taxes but didn’t pay them?

Even though your employer didn’t pay the taxes, you can still claim the income as if it were paid when you file your tax return. You also get credit for the social security and medicare payments that were withheld from your paycheck. You can also report your employer for employment tax fraud by calling the IRS. 

Does the IRS audit payroll tax returns?

The IRS can audit your payroll tax returns to see if they were filed accurately. As of 2023, the IRS plans to focus on auditing ERC claims on 2020 and 2021 payroll tax returns.

Get Help With Unpaid Payroll Tax Penalties

Have you incurred payroll tax penalties? Want help applying for penalty abatement? Need help filing back payroll taxes? Regardless of your exact situation, we can help you out. The attorneys at the W Tax Group have extensive experience helping business owners with payroll tax penalties and other business tax issues.