Payroll Tax Pitfalls
- IRS Suspends Processing of Employee Retention Credits - September 26, 2023
- Clarifying Employee Credits: How to Receive Payroll Tax Refunds - November 15, 2022
- Infrastructure Bill Would End the Employee Retention Credit - October 7, 2021
Payroll taxes and withholding present a tempting source of working capital for a small business. Payroll tax payments are easy to divert because there isn’t really an invoice (at first). Payroll taxes and withholding are ‘voluntarily’ reported on IRS Form 941 (Employer’s Quarterly Federal Tax Return) and paid via direct deposit to the IRS. The IRS does not typically pursue unpaid payroll tax liability for a year or two so, at the outset, employers may find it easy to keep the funds. Many business owners believe that they can file 941 Forms that underreport tax liability and pay in lower amounts than actual withholding. These schemes do not end well as this business owner found out.
Thomas O’Connell owned and operated three plumbing businesses and from at least 2005 through 2016 did not pay federal employment taxes for several quarters. Instead, he directed payments to other creditors and to his personal expenses. The federal tax loss from O’Connell’s conduct totaled more than $550,000. This may sound like a lot of money but it was only around $950 per week. Mr. O’Connell apparently did not spend the money on lavish assets, he probably just used it to keep cash in the bank. Sentencing is June 24, when he faces a maximum of five years in prison, a period of supervised release, restitution and monetary penalties.
The IRS is very concerned about employment tax diversion. They view this differently than they view failure to pay income tax because employment taxes are paid into Social Security and withheld from employee paychecks. Employment “tax” payments have two components, the Employer’s portion of Social Security and Medicare, which is a payment made by the Employer on behalf of the worker, and taxes withheld, which are the Employees’ portion of Social Security and Medicare and the amounts withheld from Employee paychecks as a prepayment of the Employees’ Federal Income Tax.
The last two items are referred to as Trust Funds as the money is actually paid by the Employees through payroll deductions and remitted to the IRS by the Employer. The IRS takes the position, and rightly so, that this was never the Employer’s money, but rather money paid by the Employees, and held in Trust by the Employer. The IRS has become very aggressive in collecting these funds. O’Connell’s case is an example of a new approach by the IRS in which they claim that the funds actually belong to the IRS, and that the Employer has stolen them. They justify their position (and the Courts have agreed) by claiming that if the Employer does not remit the funds, the IRS is forced to make good on the deficiency by accepting the amount withheld from paychecks as taxes paid by the Employee. The IRS considers this theft and is very aggressive in pursuing this in Federal Court.
The moral of the story is, if you need additional money in the bank, borrow it from the bank. If you look to the IRS as a short term of cash, you may end up with a long-term problem.