By Stuart Simon
In tough times, there is temptation to delay payments and preserve cash. One obligation that must never be delayed is payroll taxes. The failure to file payroll tax returns and/or pay payroll taxes in a timely fashion will result in substantial penalties. As interest is charged on both unpaid taxes and penalties, the amounts due can rapidly compound to a point where it may not be possible to pay them.
In addition, state agencies, such as the California Employment Development Department, have similar requirements and penalties.
The primary payroll tax return for businesses is filed on Form 941, Employer's Quarterly Federal Tax Return. This return is filed four times per year and is due on the last day of the month following the end of each calendar quarter. For example, the return for the quarter ending December 31, 2009 must be filed on or before January 31, 2010. The taxes reported and paid on Form 941 are the employer and employees' FICA taxes, both Social Security and Medicare taxes, and federal income tax withholdings.
The failure to timely file a payroll tax return will result in a penalty of 5 percent of the unpaid tax due with the return for each month or part thereof up to a maximum penalty of 25 percent of the tax due.
Payments of payroll taxes are somewhat complicated as the timing of the payments vary from business to business depending upon the amount of taxes dues. For small businesses, with taxes of less than $2,500 per quarter, taxes may be paid with the Form 941, using the Form 941-V, Payment Voucher. All other businesses are required to make deposits using the Electronic Federal Tax Payment System ("EFTPS"). The frequency of deposits depends upon the business's payroll taxes during the previous four-quarter look-back period. If the quarterly amount in the look back period was $50,000 or less, but at least $2,500, taxes are deposited on a monthly basis. If the amount during the look-back period was more than $50,000, deposits must be made on a semiweekly basis. Deposits generally are due three business days after the employer's payday. For deposits of $100,000 or more, the deposit is due the next banking day after the payday.
Failure to properly make deposits generates substantial penalties. Deposit penalties are determined using calendar days, starting from the due date of the liability. The penalty is 2 percent for deposits made one to five days late; 5 percent for deposits made 6 to 15 days late; 10 percent for deposits made 16 or more days late, and for deposits made at an unauthorized financial institution. The penalties are paid directly to the IRS, or with the tax return.
Amounts subject to electronic deposit requirements, but not deposited using EFTPS are subject to a 10 percent penalty. A 15 percent penalty is imposed on amounts still unpaid at the earlier of 10 days after the date of the first notice from the IRS asking for the tax due, or the day the employer received notice and demand for immediate payment.
In addition to deposit penalties, there is a failure-to-pay penalty if the payroll taxes are not paid by the due date of the payroll tax return. The failure-to-pay penalty is 0.5 percent per month or any part of a month for each month the taxes are unpaid. The maximum failure-to-pay penalty is 25 percent of the tax due.
If the portion of the payroll taxes representing the employees' federal income, FICA Social Security or Medicare taxes are not withheld, not deposited or not paid to the United States Treasury, responsible persons may be held personally liable for the taxes if the "trust fund recovery penalty" applies. The trust fund recovery penalty is equal to 100 percent of the taxes that were withheld from employees (the "trust fund taxes"). The trust fund recovery penalty applies jointly and severally to all persons who are determined to be responsible for collecting, accounting for, and paying over the trust fund taxes, and acted willfully in not doing so. A "responsible person" can be an employee, an officer of a corporation, a partner of a partnership, an accountant, a volunteer director/trustee or a sole proprietor. Essentially, a "responsible person" may be someone who signs checks for the employer or otherwise has the authority to cause the spending of business funds. "Willfully" means voluntarily, consciously and intentionally. A responsible person acts willfully if the trust fund taxes are not paid and any other creditor is paid.
There may be several responsible persons, but any of them can be held liable for the entire amount of the trust fund taxes. Once the trust fund recovery penalty is assessed, the government may use all collection methods to collect, including levying on bank and brokerage accounts and garnishing wages. In addition, the liability for trust fund taxes is not dischargeable in bankruptcy.
The failure to pay payroll taxes can be devastating. The amount of unpaid taxes, coupled with penalties and interest can more than double the liability in a few years. With payrolls being paid two to four times a month and the payroll tax returns due quarterly, it takes little time for the unpaid taxes, penalties and interest to reach an overwhelming amount. The Internal Revenue Service aggressively pursues liabilities and shuts down businesses when it is concerned that the payroll taxes will not be paid and the amount of unpaid taxes will increase. Usually, the IRS will pursue responsible individuals for the trust fund penalty only after the liability cannot be satisfied from the assets of the employer. From the perspective of an insider at a failing business, whether trust fund taxes are satisfied before the employer's share of unpaid payroll taxes may be critical.
Stuart Simon is senior counsel in the Los Angeles office of law firm Buchalter Nemer.