Payroll taxes collected by employers from employee paychecks and remitted to the government make up more than 70% of all taxes collected. They can also lead to trouble because, especially in hard times, employers can be tempted to use tax withholdings to fund the business.
Advisors and their business-owning clients should be awawre that the federal government has made payroll tax enforcement a sharper priority, tax specialists say.
“In addition to civil penalties, interest and income tax liability, criminal liability can also arise,” said David A. Shuster, managing principal and director of Tax Controversy Services at Friedman LLP’s New York office.
“When employment taxes are not paid, the IRS [investigates] to determine which owners or key employees are responsible for the employer’s failure to comply and looks to collect from those individuals instead,” added Miri Forster, partner and national tax controversy leader at EisnerAmper in Iselin, N.J.
If money intended for payroll taxes is traced to personal use, the IRS reviews 1040 tax return forms to determine if the funds have been reported as income. “If not,” Forster said, “the result could be both employment tax and income tax issues.”
This is an area of the tax code that business owners may not be familiar with, advisors say.
“Personally, liability can arise not only for what was withheld and not paid over to the government but also for what should have been withheld but wasn’t," Shuster said.
Corporate entities do not provide any protections in terms of liability, he added.
“Once the payroll taxes are withheld, they must be paid over,” he said. “If they’re used to pay another creditor of the business, that alone will usually establish the willfulness prong of responsible person liability, making the responsible person personally liable for the unremitted taxes. If a corporate shareholder or LLC member is a responsible person, the form of entity won’t insulate that shareholder/owner from being liable for the entity’s payroll taxes.”
There are situations in which the IRS will work with businesses that have unmet tax obligations, the agency says.