The IRS Heightened Enforcement for Unpaid Payroll Taxes
The Internal Revenue Service (IRS) has now upped the ante for employers who are behind on payroll taxes
aka the Trust Fund Recovery Penalty" under Section 6672.
Starting in June, the IRS has made it clear that its revenue officers will now be tracing where the unpaid payroll tax money actually went during their “trust fund investigation.” If it is determined that money went either to the owner or was spent for the owner’s benefit, the owner will now be facing a double whammy of the unpaid income taxes on those funds - meaning that both the business and the individual(s) responsible for the unpaid taxes will be penalized. In other words, if a business owner is pocketing payroll tax remittances to maintain a luxury lifestyle, it will more likely lead to prosecution.
What are Payroll Taxes
Payroll taxes are taxes collected by employers from employee paychecks and remitted to the government. This revenue is make up more than 70% of all taxes collected. and is used to finance social insurance programs like Social Security, Medicare, and unemployment insurance. The largest of these social insurance taxes are the two federal payroll taxes, which show up as FICA and MEDFICA on employees pay stub. The first is a 12.4 percent tax to fund Social Security, and the second is a 2.9 percent tax to fund Medicare, for a combined rate of 15.3 percent. Half of payroll taxes (7.65 percent) are remitted directly by employers, while the other half (7.65 percent) are taken out of workers’ paychecks.
According to recent Tax Foundation research*, these social insurance taxes make up 23.05 percent of combined federal, state, and local government revenue – the second largest source of government revenue in the United States and thus, payroll tax collections are critical to the ability of the government to function. Because of this, the IRS and other taxing authorities have prioritised payroll taxes enforcement for those who are delinquent.
Why are small businesses often get in trouble for failing to pay payroll taxes?
As mentioned, half of payroll taxes are remitted directly by employers, while the other half are taken out of workers’ paychecks and are held in trust by the employer (hence the name, "Trust Funds". During hard times, the employee portion of payroll taxes can easily be taken by the employer to fund the business. The payroll tax debt, however, is much harder to pay back because of the hefty penalties and interest accumulated on the balances. Further, the payroll periods where the business is behind often roll into one another, so by the time the IRS catches onto the issue, the liability has accumulated to such extent that most businesses simply cannot afford to pay the liabilities in full without disrupting its cashflow.
The Collection Process
The IRS pursues the unpaid payroll liabilities through civil enforcement against the company and by assessing the responsible individuals for the unpaid portion of the taxes that was withheld from the employee’s pay, referred to as the "Trust Fund Recovery Penalty" under Section 6672.
The employer would be assigned to a Revenue Officer in the IRS Collection Division who would complete a trust fund investigation to determine how much was indeed owed and who was responsible for the failure of the employer to pay the payroll taxes. That revenue officer would propose the trust fund assessments against the responsible owner and/or key employees. Notice of federal tax lien would be filed and, in cases where it appeared the failure to account and pay over the payroll taxes was intentional, the IRS could pursue the case criminally. Criminal violations are referred to the Department of Justice (DOJ) for prosecution under either Section 7201, Section 7202, or both. The DOJ could also see court orders against recalcitrant owners to make sure they reported and deposited properly or would be shutdown.
For employers where the payroll tax money was not paid to the government, revenue officers are instructed to pull the owner’s 1040 income tax returns to see if that money was reported as income. If the money was not picked up as income on the personal tax return, the revenue officer will either submit the returns and investigation records to the civil audit division for assessment of the tax and 75% civil fraud penalty or, if significant enough, simply refer the case to the IRS Criminal Investigation Division to review for criminal prosecution.
This means if the payroll tax debt routinely accrued and intentional, the civil violations might turn into a criminal tax nightmare in waiting. Tax professionals and business owners must perform a comprehensive review to determine where the payroll tax money went. If the unpaid tax money was used for or paid to the business owner, preemptive amending of income tax returns must be done before the IRS shows up, otherwise the potential fallout from not doing so may be much worse.
If you have additional questions regarding payroll taxes delinquency or know someone that needs help with their payroll taxes, contact us at (720) 712-7724 or book a FREE consultation using the link: https://calendly.com/rpfs/consult-with-ea
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*Research conducted by Tax Foundation. More information can be found here