The Internal Revenue Service assesses penalties and interest on an employer's account when they fail to collect, report, and remit payroll taxes. You can be held personally liable for failing to withhold employee taxes or to pay withheld income taxes and other payroll taxes to federal agencies.
Employers are still ultimately responsible for these tasks and obligations, even if they outsource the job to a payroll service or a bookkeeper.
What Are Unpaid Payroll Tax Penalties?
The IRS lists numerous requirements and penalties for failure to meet payroll duties in IRS Publication 15: Employer's Tax Guide, but some are more common than others. The most frequent missteps are for Form 941 taxes—withholding and FICA taxes—but some apply to other similar forms.
- Failure to file Form 941 and similar forms will result in a 2% penalty if you're one to five days late, a 5% penalty if you're six to 15 days late, or 10% if you're more than 16 days late or within 10 days of first notice from the IRS. The maximum penalty is 15%.
- Failure to provide information returns to employees, such as Forms W-2, and other payees on Form 1099-MISC can also mean IRS penalties. The amount of these penalties depends the size of your company. Larger companies with gross receipts over $5 million pay more. Penalties can also depend on the type of error, how late the payment was, or whether the payment was made at all.
- A trust fund recovery penalty (TFRP) is charged for failure to pay payroll taxes when they're due. You could be held responsible for this penalty if income tax, Social Security, or Medicare taxes are withheld from pay but not remitted to the government. The TFRP is equal to the unpaid tax. Interest additionally accrues from the due date.
The TFRP penalty requires "willful" failure to take action, but you can still face fines for late payments, even if you can prove that your failure to pay or report taxes wasn't intentional.
Deposits are applied to the most recent liability, so be careful not to make them late.
How Do Unpaid Payroll Tax Penalties Work?
Let's say you're required to make a deposit of $1,500 every month. You don't make your March 15 deposit, but you make a deposit of $2,000 on April 15 to catch up. Of that payment, $1,500 is applied to April 15, and $500 to March 15, so you could be assessed a penalty for the $1,000 that wasn't deposited for March 15.
You can also be penalized for unpaid payroll taxes if you misclassify employees as independent contractors. You don't have to withhold income taxes or FICA taxes from payments made to independent contractors, but you could face penalties if the IRS finds that they were misclassified and should have been paid as employees because they haven't met the qualifying rules for independent contractors.
Penalties on deposits due from Feb. 8 through Feb. 23, 2021, will be abated for employers in Oklahoma, provided that these deposits were received by Feb. 23, 2021. Texas employers had a similar window of time: penalties on deposits due from Feb. 11 through Feb. 26, 2021 were abated until Feb. 26, 2021. The IRS announced several tax extensions for these states in response to the severe winter storms of February 2021.
Payroll Taxes Are Trust Fund Taxes
Trust fund taxes are those collected from someone, typically a customer or an employee, then held by a business "in trust" until they're turned over to the appropriate taxing entity. Sales tax and payroll taxes are the most common types of trust fund taxes.
The IRS can impose the trust fund recovery penalty for these unpaid taxes when a business doesn't make payments on time. 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
The failure must meet these "willful" tests and be committed by a party who was responsible for the failure. The IRS defines willful as "voluntarily, consciously, and intentionally." A responsible person 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 to show willfulness.
Types of Payroll Taxes
The IRS calls payroll taxes employment taxes. They're those that your business is required to withhold and pay when you have employees. These taxes include:
- Federal and state income taxes, which must be withheld from employee pay and paid to the IRS as required by law.
- Social Security and Medicare taxes, commonly referred to as "FICA taxes," which must be withheld from employee pay and matched by employers. FICA taxes must be paid either semi-monthly or monthly, depending on the size of your payroll, and reported quarterly on Form 941.
- Federal unemployment taxes, which 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.
- State unemployment taxes, which must be collected, reported, and paid according to state laws.
Requirements for Payroll Taxes
Payroll taxes must be held separately from other business funds, because they're trust fund taxes. Let's say that Unnamed Corporation has several employees, and the company withholds $5,000 in federal income tax and $2,000 in FICA tax from all the employee paychecks for one payday.
- 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.
- All employers are required to withhold income tax, Social Security tax, and Medicare tax from employees' pay and report and submit these amounts to the IRS.
- Employers must also match the Social Security and Medicare taxes that were withheld and pay these sums to the IRS.
- The IRS assesses monetary penalties ranging from 2% to 100% of the unpaid tax when employers willfully disregard these requirements, depending on the type of tax.
- Penalties can be charged even if you’re simply late with submitting payments.