The IRS assesses penalties and interest on the employer's account when they fail to collect, report, and remit payroll taxes. You may be personally liable for failure to withhold employee taxes or failure to pay source deductions and other payroll taxes to federal agencies.
Employers remain responsible for these tasks and obligations, even if they outsource the work to a payroll department or accountant.
What are unpaid payroll tax penalties?
The IRS lists several requirements and penalties for non-compliance with payroll obligations in IRS publication 15, but some are more common than others. The most common errors are with Form 941 taxes (withholding and FICA taxes), but some apply to other similar forms.
If you do not complete Form 941 and similar forms, you will receive a 2% fine if you are one to five days late, a 5% fine if you are 6 to 15 days late, or 10% if you are over 16 years old days late or within ten days of the first IRS notification. The maximum penalty is 15%.
Failure to comply with information returns to employees, such as W-2 forms and other recipients of Form 1099-MISC, can also result in IRS penalties. The amount of these fines depends on your business's size, and larger businesses with gross revenues over $5 million pay more. Sanctions may also depend on the type of error, late payment, or whether payment has not been made.
A trust fund recovery penalty (TFRP) is applied in the event of non-payment of social charges when due. You may be liable for this fine if income tax, Social Security, or Medicare taxes are withheld from your payment but not remitted to the government. The trust fund recovery penalty (TFRP) is equal to the unpaid tax. Also, interest accrues from the due date.
The compensation penalty requires an "intentional" omission of the action. Still, you can face late payment penalties, even if you can prove that the non-payment or the tax return was unintentional.
Deposits apply to the most recent liability, so be careful not to delay them.
How do unpaid payroll penalties work?
Suppose you have to deposit $1,500 each month, and you do not deposit on March 15, but deposit $2000 on April 15 to catch up. Of this payment, $1,500 applies on April 15 and $500 on March 15, so you may receive a fine of $1,000 that was not filed on March 15.
You can also be punished for unpaid payroll taxes if you incorrectly classify employees as independent contractors. You are not required to withhold income tax or FICA tax from payments made to independent contractors. Still, you may face penalties if the IRS determines that they were misclassified and that they should have been paid as employees because they did not meet the requirements of the contractor.
Payroll taxes are trust funds taxes.
Taxes on trust funds are collected by someone, usually a client or employee, and withheld by a company "in custody" until they are transferred to the appropriate tax agency. Sales taxes and payroll taxes are the most common types of trust fund taxes.
The IRS may impose a trust fund recovery penalty for these unpaid taxes when a business fails to make timely payments. The trust fund recovery penalty (TFRP) may impose compensation for:
Willful attempt to evade or waive the charge or payment.
Willful failure to account for and intentional payment of taxes
Willful failure to collect taxes
The failure must meet these "willful" tests and be committed by one of the parties responsible for the failure. The IRS intentionally defines wilful as "intentional, voluntarily, and consciously." A responsible person with choice or free either intentionally ignores the law or is indifferent to its needs. In some cases, a reckless disregard of the obvious facts is enough to show willfulness.
Types of Payroll taxes
The IRS calls payroll taxes, employment taxes. These are what your business should keep and pay for when it has employees. These costs include:
As an employer, you must pay federal unemployment taxes based on all employees' gross wages. These fees are paid quarterly or annually and are reported on Form 940.
Federal and state income taxes must be withheld from the employee's payment and paid to the IRS by law.
Social security and health insurance taxes, commonly known as FICA taxes, must be withheld from the employee's salary and compensated by employers. FICA taxes must be paid every two weeks or monthly, depending on the size of your salary, and must be reported quarterly on Form 941.
State unemployment taxes must be collected, declared, and paid per state law.
Other payroll-related tax obligations include annual payroll and tax returns for employees on the W-2 form and for non-employees on the 1099-MISC form.
Payroll taxes requirements
Payroll taxes should be kept separate from other corporate funds because they are trust funds taxes. Suppose ABC Corporation has more employees, and the company withholds $5,000 in federal income taxes and $2,000 in FICA taxes from all employee salaries for a payday.
The $5,000 federal income tax must be paid to the IRS.
The FICA tax of $2,000 must be paid to the IRS for Social Security Administration, along with the additional $2,000 that the company owes as part of the FICA tax.
The business must keep this $9,000 separately in its accounting system and make payments to the IRS on the due date.
Summary
All employers must withhold income tax, Social Security tax, and Medicare tax from the employee and report and file these amounts with the IRS.
Employers must also pay Social Security and Medicare tax withholding and pay these amounts to the IRS.
Penalties can be charged even if you simply delay sending payments.
The IRS assesses fines ranging from 2% to 100% of unpaid tax when employers willfully ignore these requirements, depending on the type of tax.
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