If you pay people to work for you, you are required to collect and pay payroll taxes. The IRS receives 70% of its annual revenue from payroll taxes, but 18% of the tax gap is due to unpaid or unreported payroll taxes. This tends to upset the IRS.
What if you're part of that 18%? That's what this post is about. You can make this right, but like unpaid income taxes, unpaid payroll taxes incur penalties and interest.
Defining Payroll Taxes
The term payroll tax covers a little ground. In general, it means all employment taxes applying to your business. Those taxes can include:
- Income taxes
- FICA taxes
- Unemployment taxes
- Other taxes - state and local
FICA includes Social Security and Medicare withholdings while income tax is withheld according to your employee’s W-4. Federal and state governments require you to pay unemployment taxes to help them pay unemployment benefits as needed.
Federal and State Taxes
Federal income tax is due monthly or semi-weekly and reported on Form 941, Employer’s Quarterly Federal Tax Return. State and local income taxes and due dates vary according to state and local law.
Federal unemployment taxes are required for businesses in one of two situations:
- If you pay $1,500 or more to employees in any single quarter
- If you have one or more employees for 20 or more weeks in a single year
Depending on how much you owe, federal taxes are paid quarterly or annually, and you must file Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, at the end of the year.
As the employer, you pay 6% of the federal unemployment tax on the first $7,000 each employee earns. You may qualify for a credit of up to 5.4% if you pay state unemployment tax as well.
For state unemployment tax, you generally must pay it in every state where you have employees. Suppose you have a distributed workforce with either remote workers or people who work at a branch of your business in a state other than yours. In that case, you need to pay the taxes according to where the employee lives and works.
State unemployment taxes are typically due quarterly, but base wage rates vary by location. Also, depending on the industry and previous unemployment claim experience, your unemployment tax liability may vary.
FICA and Forms
Where would the government be without its forms?
IRS Form 941, Employer's Quarterly Tax Return (the same as above), is the form to file each quarter. FICA taxes are paid either monthly or semi-weekly, depending on the size of your payroll.
The withholdings include Social Security and Medicare. You pay the employer's share and withhold the employee's share to pay to the government.
Employee Wage and Tax Reporting
You must provide each employee a W-2, Wage, and Tax Statement by January 31 of the following tax year. If you pay independent contractors, you need to send each a Form 1099-MISC, Non-employee Compensation.
If you miss the deadlines for distributing these forms, you will pay penalties. The IRS loves its penalties.
How to Calculate Your Payroll Taxes
FICA taxes are pretty straightforward. The IRS charges a flat percentage rate of the employee’s gross wages.
Social Security requires you to deduct 6.2% of the employee’s gross wages until you hit a wage base, which changes according to the tax law.
For Medicare, you must deduct 1.45% of the employee's gross wages. Together with Social Security, you withhold 7.65% of each employee's gross wages, and then you, as the employer, must match that.
If you pay any employee an income above a specific threshold, you must withhold an additional 0.9%.
The IRS and state taxing authorities require you to accurately complete your wage and tax reporting forms on time. If you miss distribution deadlines, you’ll pay penalties.
Calculate payroll taxes every pay period. Determine individual withholding according to employee certificates and federal and state income tax brackets.
What sort of penalties could you face if you don’t pay payroll taxes? Any of the following:
- Monetary penalties
- Interest on back taxes
- Liens against your property
- Civil and criminal sanctions
- Jail sentences
The amount of the penalties depends on several factors, including:
- The type of infraction
- The size of your business
- How much you owe
- Whether the payment was late or never received
The fees for all this continue to increase according to how long the payments are past due. They build up quickly.
- Late one to five days - you pay 2%
- Late six to 15 days - you pay 5%
- Late more than 16 days - you pay 10%
- If you wait until more than ten days past your first IRS notice, you pay 15%
Oh, the IRS notice? That’s how you know you owe. The agency sends a notice or letter telling you of your Failure to Deposit Penalty.
No, this isn't a text abbreviation. It stands for Trust Fund Recovery Penalty, a fancy name for the program that decides whether your tax issues are by mistake or on purpose.
TFRP is based on willful failure to collect and pay payroll taxes. An employer may be found willful if it:
- Were or should have been aware of outstanding taxes and
- Intentionally disregarded the law or were indifferent to its requirements
Willful failure to pay is much worse than making a mistake. However, you can seek an abatement by providing reasonable cause for your unreported taxes or late payments. Any of the following are considered reasonable:
- Fire or natural disaster
- The inability to obtain records
- Death or serious illness
- The unavoidable absence of the taxpayer or immediate family
Be prepared to provide documentation or physical evidence of disaster.
And, no, just because you don’t have the money doesn’t count. Lack of funds is not considered a reasonable cause.
How to Avoid Penalties
It's always better to avoid penalties than to pay them. And there are several ways to make sure you stay on the right side of the IRS (and the state and local tax authorities; you mustn't forget about them).
Improve Payroll Processes
Ensure your payroll process monitors, withholds, and reports all compensation paid to employees. Remit and report all taxes withheld from wages on time.
Stay Up to Date with IRS Announcements
The IRS publishes news releases and tip sheets to help employers remain aware of changes in tax law and new form submission guidelines. If you pay state payroll taxes, be sure to pay attention to those as well. Most states have a website where they put news releases and tax law changes.
Keep an Unemployment Tax Budget
Make unemployment taxes part of your overall business budgeting process. If you don't, you may find yourself short when it's time to pay. Most businesses create a separate account for payroll taxes to make things easier to manage.
Maintain Proper Employee Classification
Employee classification can be complicated. Do you have employees or independent contractors? It’s appealing to classify everyone as an independent contractor to lower your tax liability, but don’t do it.
Carefully check the IRS and state tax law definitions of employee and independent contractor and follow them to the letter.
Use a Payroll Provider or Software
You have several choices of payroll software that provide all the tax services you need to report and remit taxes accurately. An alternative is to hire a provider to take care of your payroll tax details. Either way, you remain responsible for the related tax obligations and paperwork.
Problems? Contact Top Tax Defenders
If you have a payroll tax problem, contact Top Tax Defenders. We have all the experts ready to work for you and get you back on the right side of the tax laws.