What Are the Penalties for Unpaid Payroll Taxes?

Underpayment of payroll tax can have serious consequences.
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Among your responsibilities as an employer is the requirement to collect, report, and pay payroll taxes as required by federal and state laws. If you are a corporate officer or other "responsible party," as defined by the IRS, you may be personally liable for payroll taxes not reported or deposited as required.

If your business outsources payroll tasks to a payroll service or bookkeeper, the IRS says you are still responsible for all payroll tax collection, reporting, and payment tasks. If the other party doesn't make payments, the IRS may asses penalties and interest on your account.

What Payroll Taxes Do I Have to Pay?

Payroll taxes (the IRS calls them employment taxes) are taxes your business must pay when you have employees. These federal and state payroll taxes include:

  • Federal and state income taxes must be withheld from employee pay and paid to the IRS (federal income taxes) and states (state income taxes) as required by law.
  • FICA taxes (Social Security and Medicare taxes) must be withheld from employee pay and matched by employers. FICA taxes must be paid either semi-weekly or monthly, depending on the size of your payroll, and reported quarterly on Form 941.
  • Federal unemployment taxes must be paid by you as the employer, based on the gross pay of all employees. These taxes are paid quarterly or annually and are reported on Form 940.

Other payroll tax obligations including annual wage and tax reporting for employees on Form W-2 and for non-employees on Form 1099-MISC.

Payroll Taxes as Trust Fund Taxes

Trust fund taxes are taxes collected from someone (a customer or employee usually) and held by a business in trust until they are paid to a taxing entity. Sales tax and payroll taxes (income tax and FICA tax) are the most common types of trust fund taxes.

How Trust Fund Taxes Work: An Example

Unnamed Corporation has employees. For one payday, the company withholds $5,000 in federal income tax and $2,000 in FICA tax from all the employee paychecks.

  • The $5,000 in federal income tax must be paid to the IRS.
  • The $2,000 in FICA tax must be paid to the IRS (for the Social Security Administration), along with an additional $2,000 the company owes as its share of FICA taxes.

The company must keep this $9,000 separate in its accounting system and make payments to the IRS when they are due.

If a business doesn't make payments on time, the IRS can impose a penalty for these unpaid taxes, called a trust fund recovery penalty (TRGP). The TFRP can be imposed by the IRS for:

  • Willful failure to collect tax,
  • Willful failure to account for and pay tax, or
  • Willful attempt in any manner to evade or defeat the tax or the payment thereof.

Note the use of the term "willful," which is defined by the IRS as "intentional, deliberate, voluntary, and knowing, as distinguished from accidental. "Willfulness" is the attitude of a responsible person who with free will or choice either intentionally disregards the law or is plainly indifferent to its requirements." In some cases, a reckless disregard of obvious facts is enough show willfulness.

Personal Liability for Payroll Taxes

You as a responsible party for your company can be held personally liable for willful failure to withhold employee pay and payroll taxes or to pay withheld income taxes and other payroll taxes to federal and state agencies.

Penalties

Penalties are complicated; this list is brief and general. The IRS provides further details on the penalties that will be assessed in Publication 15: Employer's Tax Guide. These penalties are for Form 941 taxes (withholding and FICA taxes) but may also apply to other similar forms.

Failure to file Form 941 and similar forms: 2% 1-5 days late, 5% 6-15 days late, 10% more than 16 days late or within 10 days of first notice from the IRS, maximum 15%.

Trust Fund Recovery Penalty for failure to pay payroll taxes when due, imposed on the responsible party. The IRS says, "If income, social security, or Medicare taxes that must be withheld are not withheld or are not paid, you [as a responsible party] may be personally liable for the trust fund recovery penalty."

Remember, the TFRP is 100% of the unpaid tax (income, social security, and Medicare), in addition to penalties, interest accrues from the due date.

Deposits are applied to the most recent liability, so be careful of making deposits late. Let's say you are required to make a deposit of $1500 every month. You don't make your March 15 deposit, but you make a deposit of $2000 on April 15 to catch up. $1500 is applied to April 15 and $500 to March 15. You may be assessed a penalty for the $1000 un-deposited for March 15.

Other Types of payroll-related Penalties

Even if you can prove your failure to pay or report taxes wasn't "willful," and you avoid having to pay the Trust Fund Recovery Penalty, you can still face fines for late payments.

You also may be penalized for unpaid payroll taxes if you misclassified workers as independent contractors instead of as employees. For example, let's say you have paid workers as independent contractors and you haven't withheld federal income taxes or FICA taxes on their income. If the IRS finds they were misclassified and should be employees, you could have a hefty bill for these unpaid taxes, plus penalties.

Failure to provide information returns to employees (Form W-2) and other payees (Form 1099-MISC) can also mean IRS penalties. The amount of these penalties depends on several factors:

  • The size of your company (larger companies over gross receipts over $5 million pay more)
  • The type of error (not filing and not giving employees or others their statements are two separate penalties)
  • The lateness of the payment (the longer it is unpaid, the higher the penalty
  • If the payment wasn't made at all, and even more if the IRS finds "intentional disregard"

This article explains the IRS collection process.