When thinking about tax obligations, companies and individuals often focus their attention on federal and state income taxes, but collecting, reporting, and remitting payroll taxes in accordance with federal, state, and local laws are equally important. The rules for payroll tax payments can be complex, but the IRS focuses much of its enforcement efforts on payroll tax compliance and penalties for not meeting the requirements are severe. Since employers bear the ultimate responsibility for satisfying payroll tax reporting and payment requirements, understanding these obligations and knowing how to prevent payroll tax penalties is a must.
Payroll Tax Obligations
Businesses with employees must withhold payroll taxes and remit them to applicable federal, state, and local tax jurisdictions. To prevent payroll tax penalties, employers need to keep special attention on calculating the amount of taxes and making timely payments. The taxes usually withheld from employee paychecks include the Federal Insurance Contributions Act (FICA) and federal, state, and local income taxes. Some states such as California, Hawaii, New Jersey, New York, and Rhode Island also require the withholding and payment of employee contributions to family medical leave or disability insurance taxes.
To ensure proper handling of payroll tax obligations, employers must:
- Pay and report federal, state, and local taxes to the appropriate tax agencies;
- Properly report wages, tax amounts withheld, and amounts paid on behalf of employees;
- Maintain the required federal, state, and local records; and
- Establish accurate and timely compliance to prevent payroll tax penalties.
Overview of Payroll Tax Penalties
Meeting payroll tax obligations is mandatory for every employer. The IRS and many states operate under a voluntary compliance system, meaning that they expect businesses to file accurate payroll tax returns without government intervention. While payroll tax audits are rare, they are often triggered by mismatched information submitted on payroll tax returns.
Businesses may not be compliant with payroll tax obligations for a variety of reasons, including a misunderstanding of the obligations, insufficient coordination with third-party payroll providers, or due to deliberate evasion. Such non-compliance will lead to payroll tax penalties. Some of the common payroll tax penalties assessed by the IRS are outlined below:
- The IRS penalizes employers who deposit their payroll taxes late. In this case, the penalty rate depends on the number of calendar days a deposit is late starting from the due date of the deposit. For liability amounts not properly or timely deposited, the penalty rates include:
- 2 percent for deposits 1–5 days late;
- 5 percent for deposits 6–15 days late;
- 10 percent for deposits made more than 15 days late or within 10 days of first notice from the IRS; and
- 15 percent for all amounts still unpaid more than 10 days after the date of the first notice or the day on which the taxpayer received notice and demand for immediate payment, whichever is earlier.
- Non-payment of payroll taxes on the due date results in a Trust Fund Recovery Penalty (TFRP). The IRS charges this penalty if employers withhold payroll tax, Medicare, and Social Security payments from employees’ paychecks, but do not send the money to the IRS. Triggering the TFRP penalty generally requires an intentional or willful failure. However, employers are charged with penalties for late payments even if they prove that failure to report or pay the taxes was not intentional.
- In addition to the late filing and late deposit penalties, businesses can be subjected to the IRS’s negligence penalty. Negligence is defined as any careless, reckless or intentional disregard of tax rules and regulations. Because this is a penalty, employers cannot claim the interest as a tax deduction.
Best Practices to Prevent Payroll Tax Penalties
Considering different consequences that employers may face, it is in the best interest of every employer to establish a sound compliance strategy and take every possible measure to prevent payroll tax penalties, such as:
1. Avoid Missing Deadlines
Missing payroll tax deadlines will cause significant disruptions to a business. Late payment penalties will accrue quickly, and tax authorities will send notices and relentless demands. If employers want to prevent payroll tax penalties for late filing, they must be careful not to miss the due dates. To that end, employers should coordinate with a reputable third-party payroll provider or utilize tax management tools, such as the IRS online tax calendar, to put taxes in order and stay compliant.
If employers still end up filing or paying late, there are exceptions that can help them avoid a penalty. The IRS and many state tax authorities may remove the deposit penalty if it is the first such penalty incurred by the employer, or if the employer can show a reasonable cause to justify the late payment.
2. Keep Accurate, Complete and Organized Records
To prevent payroll tax penalties, it is important to keep accurate, complete, and current payroll records for all employees, including Forms W-2, time sheets, and pay records. Also, the IRS requires employers to keep most employee and payroll records for at least four years while the Small Business Administration (SBA) recommends keeping all payroll records for six years since some states have different requirements.
In addition to this, employers should check employees’ information as filing taxes with outdated employee information data can result in penalties. Before filing the taxes to the IRS, it is advisable to check the following:
- Employee’s full name;
- Start or termination of employment;
- Date of birth;
- Updated addresses;
- Tax file numbers; and
- Payroll details.
If any of this information changes, the payroll or HRIS database should be updated immediately to avoid mistakes and make payroll taxes easier to account for.
3. Monitor IRS Announcements and Resources
Another way to prevent payroll tax penalties is to stay on top of IRS announcements. Claiming ignorance is not an acceptable reason for non-compliance with the IRS. Even if the mistake was unintentional, employers can still face penalties.
The IRS is continually publishing news releases, tax return news and tax law updates, tax tips and form deadlines, so it is important to stay alert, especially before the tax filing season. Also, employers should pay attention to the laws and the tax regulations in different states in which their employees work.
Reducing Payroll Tax Penalties Risks
Failing to meet payroll tax obligations can happen to any business due to the variety and complexity of different responsibilities they need to keep track of. With that, it is important to have a payroll tax compliance system and/or a reputable third-party payroll provider in place to prevent payroll tax penalties and protect businesses from potential financial losses and closures.
Also, having reliable payroll tax management software can make the payroll tax processing more efficient, help employers eliminate costly mistakes and ensure more accurate results. As a result, they can prevent payroll tax penalties, reduce administrative tasks, ensure employees are paid accurately and on time and stay compliant with the IRS requirements as well as state payroll tax regulations.