Small business owners in distress over unpaid taxes may end up in your office, looking for information, guidance, and hope. The full breadth and range of tax problems keeping people awake at night is practically endless, but there is one issue that you will see again and again: unpaid payroll taxes. This is one of the most common reasons that businesses fall afoul of the IRS, and unfortunately, it is one of the most serious.
The IRS pursues this type of liability much earlier and much more aggressively than cases of unpaid personal income tax, and the consequences can be swift and severe.
Why Do Businesses Get Into Payroll Tax Trouble? Payroll taxes, also known as employment taxes, are made up of three parts:
The federal Social Security and Medicare taxes that employers are required to withhold from employees’ paychecks.
The matching part of federal Social Security and Medicare taxes that employers are required to contribute.
These payroll taxes are called trust fund taxes by the IRS because the funds are held in trust, and that is the reason the IRS takes such a strong stand against nonpayment here. The IRS regards falling behind on filing and submitting payroll taxes as a type of theft, as the funds never belonged to the business in the first place.
For the average small business owner with cash-flow issues, making regular payments to the IRS can feel like a burden. When they are struggling to make ends meet during a downturn, it can be incredibly tempting to pay the rent or settle accounts with demanding creditors before paying the IRS. Filing late feels like a temporary loan to bridge a gap, and seems harmless, but the results are anything but.
Note: The IRS takes failure to pay payroll taxes, especially with respect to active businesses, very seriously and often assigns field agents to stop businesses that accrue payroll tax liability over more than two quarters.
Investigation and Consequences The IRS considers unpaid payroll taxes a very serious violation. The agency will send out reminder notices once a business has missed a payment or two, but it may not wait long before it sends a revenue officer out to the business in person, unannounced. This is when the business owner will probably be given Form 9297, Summary of Taxpayer Contact, and Letter 1058, Final Notice of Intent to Levy and Notice of Your Right to a Hearing. Things can start to snowball pretty quickly after that.
The following are three actions the IRS could take:
Trust fund penalty assessments. The IRS will not only be attempting to collect the unpaid funds, but it is also likely to be launching an investigation against the business and the people associated with that business: the trust fund penalty investigation.
Like all unpaid taxes, payroll taxes begin to collect penalties and interest, but the trust fund penalty is a special case. It is equal to the amount of the unpaid tax, and crucially, it can be assessed not only against the company, but against anyone who the IRS determines is a “responsible person.” This can be anyone who has ever signed a paycheck or who could be considered to have knowledge of the workings of the business and willfully decided to withhold payment. It could be the business owner or even an involved accountant or CPA.
The trust fund penalty investigation is a harrowing experience: The IRS issues an administrative summons to the bank accounts and copies of the business’ bank signature cards and copies of its canceled checks. The signers may become targets, even if they were not decision-makers, and the problem is that the IRS takes a “guilty until proven innocent” stance. It is up to the individual to prove that he or she should not be held liable.
Note: The IRS revenue officers will usually conduct in-person interviews between different members of the company. Often the revenue officer will try and get individuals to point the finger at different people, with the hopes of having multiple people to assess with a trust fund liability penalty. The IRS will then pursue those individuals and their individual assets, including bank accounts, liquid assets, and even the equity in their homes.
Collection tactics. The IRS has the legal right to collect the unpaid payroll tax in almost any way it sees fit. The agency is not likely to accept payment plans if it believes it can collect the balance in full, and it has the ability to shutter a business without a court order through levying the business’ operating account and to liquidate assets. The IRS can go after the personal assets and bank accounts of any individual deemed responsible, and payroll tax debt is not dischargeable in bankruptcy.
Criminal proceedings. Responsible individuals can also find themselves investigated for and charged with a federal felony, if the investigation uncovers suspected fraud.
As you can see, the IRS pulls no punches when pursuing unpaid payroll taxes. If you are a business owner, you owe it to yourself to stay on top of these taxes to keep the IRS at bay.
Sam Brotman is a practicing attorney in San Diego and the founder of Brotman Law. His practice primarily centers on all aspects of tax litigation and criminal/civil tax controversies in front of the IRS, Franchise Tax Board, Employment Development Department, Board of...