As an employer, you’re responsible for withholding and remitting payroll taxes. But, what happens if you don’t pay them? Who takes over the unpaid payroll tax burden? Keep reading to find out who is responsible for unpaid payroll taxes.
Overview of payroll taxes
Before we jump headfirst into learning who is liable for unpaid payroll taxes, let’s briefly recap what payroll taxes are.
Payroll taxes consist of federal, state, and local income taxes, federal and state unemployment taxes, state-specific taxes, and FICA tax.
Withhold federal, state, and local income taxes, Social Security and Medicare taxes, and some state-specific taxes (if applicable) from employee wages.
Typically, the employer is responsible for paying federal and state unemployment taxes (FUTA and SUTA taxes). However, employees in Alaska, New Jersey, and Pennsylvania must also pay state unemployment tax.
FICA tax (Federal Insurance Contributions Act) is made up of two taxes: Social Security and Medicare. Both you and your employee contribute to FICA tax. FICA tax is 15.3% of each employee’s taxable wages. Take a look at how FICA tax breaks down:
- Social Security tax: 12.4% of FICA tax
- Employer: 6.2%
- Employee: 6.2%
- Medicare tax: 2.9% of FICA tax
- Employer: 1.45%
- Employee: 1.45%
You only have to contribute and withhold Social Security tax up to the Social Security wage base, which typically changes from year to year. When an employee earns more than a certain amount, you must also withhold an additional percentage (0.9%) from their wages for Medicare tax. However, as an employer, you are not responsible for contributing to the additional Medicare tax rate.
Who is responsible for unpaid payroll taxes?
Now onto the good stuff. The part you’ve all been waiting for: who is responsible for unpaid payroll taxes?
It all boils down to a person … a “responsible” person, that is. When a business fails to remit payroll taxes, the IRS has the ability to collect said taxes from “responsible persons.” So, what counts as a responsible person?
A responsible person is anyone within or outside of the business with significant control or influence over the company’s finances. According to the IRS, this can include a single person or a group of people who have the duty to perform and the power to direct the collecting, accounting, and paying of trust fund taxes.
The employee portion of Social Security and Medicare taxes and income taxes are considered “trust fund taxes” because you withhold them from employee wages and hold them in a “trust” until they need to be paid to the IRS.
A responsible person or persons may be one of the following:
- Officer or an employee of a corporation
- Member or employee of a partnership
- Corporate director or shareholder
- Member of a board of trustees of a nonprofit organization
- Another person with authority and control over funds to direct their disbursement
- Another corporation or third-party payer
- Payroll Service Providers (PSP) or responsible parties within a PSP
- Professional Employer Organizations (PEO) or responsible parties within a PEO
- Responsible parties within the common law employer
Trust Fund Recovery Penalty
So, how do the unpaid payroll taxes land in the hands of one of the people above? If the payroll taxes are not paid in the correct amount and on time, the IRS can impose a hefty penalty called the Trust Fund Recovery Penalty (TFRP).
The employees’ total withholdings (the employee portion of FICA tax and income taxes) are the taxes subject to the TFRP.
The TFRP may be assessed against anyone who:
- Is responsible for collecting or paying withheld income and employment taxes, or for paying collected excise taxes AND
- Willfully fails to collect or pay them
For willfulness to exist, the responsible person must have:
- Been, or should have been, aware of the outstanding taxes AND
- Either intentionally disregarded the law or was plainly indifferent to its requirements (no evil intent or bad motive is required)
The willfulness plays a huge role in whether a “responsible person” can be held liable for a business’s unpaid payroll taxes.
In short, the IRS can impose the penalty on any person who is “responsible” for paying the business’s payroll taxes and willfully fails to do so.
How much is the penalty?
The TFRP can be pretty hefty. The penalty is generally 100% of the taxes withheld and not remitted to the IRS. The TFRP can basically double the original tax liability.
For example, say the business owes $2,000 in payroll taxes to the IRS. The TRFP amount is $2,000, meaning that the responsible person would owe the IRS $4,000 total.
Failing to pay payroll taxes can also lead to criminal charges, jail time, and a shuttered business.
TFRP and the Social Security tax deferral
So at this point, you may be wondering, What if I’m deferring the employee portion of Social Security tax under the August 8, 2020 executive order? If you’re taking advantage of the Social Security tax deferral, the employee portion of Social Security tax will not be considered unpaid if you pay it back on time.
As a reminder, the deferral period takes place between September 1, 2020 – December 31, 2020. And, you have between January 1, 2021 – April 30, 2021 to remit the deferred employee SS tax portion to the IRS. If you fail to repay the deferred employee SS tax by April 30, 2021, you will be penalized.
Assessing the TFRP
If the IRS determines someone to be a responsible person, they will send that person a letter stating that they plan to assess the penalty against them.
Once the responsible person receives the letter, they have 60 days from the date of the letter to appeal. If the responsible person does not respond to the IRS’s letter, the IRS assesses the penalty against them and sends a “Notice and Demand for Payment.”
What about the employer portion of payroll taxes?
Again, the TFRP only applies to the employee portion of payroll taxes. So, who’s responsible for the unpaid employer portion of payroll taxes?
Instead of making a personal assessment against anyone who is “willful” or “responsible,” the IRS can only look to the actual business to recover this portion of the payroll taxes.
However, if you qualify for an Offer in Compromise for unpaid payroll taxes, you may be able to avoid repaying the full employer portion.
Avoiding unpaid payroll taxes and the TFRP
Want to steer clear of the TFRP altogether? Who can blame you? To avoid unpaid payroll taxes as well as any penalties, you can:
- Withhold, contribute, and set aside taxes in advance
- Create a separate payroll tax fund or account
- Utilize payroll software to track and pay payroll taxes
- Keep a running record of how much you owe in payroll taxes (e.g., spreadsheet)
- Hire an accountant
- Set reminders for yourself for when payroll taxes are due (e.g., mark your calendar)
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This is not intended as legal advice; for more information, please click here.