There is zero wiggle room when it comes to handling the federal income taxes and FICA taxes withheld from employees’ paychecks. The taxes are government property, which employers hold “in trust” and then remit to the IRS on a set schedule. Employers are not permitted to use this “trust fund” money for other purposes.
SERIOUS PENALTY
The penalty for breaking the rules is harsh. Any person involved in collecting, accounting for, or paying the trust fund taxes — a “responsible person” — who willfully fails to do so may be liable for a penalty equal to 100% of the unpaid taxes. The penalty is aggressively enforced.
RESPONSIBLE PERSONS
Generally, a responsible person is anyone with the power to ensure that the taxes are paid. This might include a corporation’s officers, directors, shareholders, employees, and partnership partners. Under certain circumstances, even family members and professional advisors may be subject to the penalty.
It’s not uncommon for there to be more than one responsible person. When that’s the case, each responsible person could be found liable for the full penalty.
A WORD ABOUT WILLFUL
Failure to pay trust fund taxes can be willful without being an intentional attempt to evade paying the taxes. Temporarily “borrowing” from the trust fund to meet bona fide business expenses in a pinch can qualify as being willful.
Maureen’s yoga center has grown faster than expected, so she’s considering using a third-party service to handle payroll processing and management.
Maureen consulted her tax professional and looked at IRS Tax Tips for guidance. She found she could best protect her business by hiring one of these types of services:
Certified professional employer organizations are generally only liable for filing employment tax returns and making deposits and payments for the taxes their customers report on wages and other compensation.
Reporting agents are generally limited to depositing taxes with the Electronic Federal Tax Payment System (EFTPS). Employers retain responsibility for seeing that filing returns are filed and taxes paid on time.
Section 3504 agents withhold, report, and pay employment taxes and share liability for all federal tax withholding responsibilities with the employer. Employer returns are submitted with the agent’s Employer Identity Number (EIN). Generally, customers must still file FUTA tax returns with their EINs.
Client Profile is based on a hypothetical situation. The solutions discussed may or may not be appropriate for you.
This last quarter of 2023 is the first time my side business has had an employee besides myself. I’m used to paying estimated taxes for my FICA responsibility, but what’s required for my new employee?
ANSWER:
Short answer: Your business generally should withhold 7.65% (6.2% for Social Security; 1.45% for Medicare) of the employee’s earned income up to $160,200 for FICA. It’s also required to match that amount on the employee’s behalf. The full 15.3% is then reported (IRS Form 941) and paid to the IRS quarterly in January (fourth quarter 2023), April (first quarter 2024), July (second quarter), and October (third quarter). We can help you.
My business is located in Michigan, but I’m considering hiring remote employees who live in other states. How will this impact my payroll taxes?
You’ll need to withhold federal payroll taxes just as you would for your in-state employees. But you’ll also need to withhold state and possibly local payroll taxes in the state where your remote worker lives.
This will require you to register your business with that state’s revenue department so you can follow their filing schedule and pay the tax on time. You’ll also need to register your company with that state’s unemployment department to pay unemployment tax.
It can get even more complicated. Now your company may also be subject to that state’s sales tax laws. Each state has different rules for when you meet the minimum requirements of doing business there. And having an employee can be the trigger.
Similarly, having an employee in another state can trigger corporate income tax for your company.
Client Profile is based on a hypothetical situation. The solutions we discuss may or may not be appropriate for you.
Whether you’re hiring your first employee or already have a few, understanding payroll taxes is a must.
FICA & FUTA
FICA stands for Federal Insurance Contributions Act and it funds the Social Security and Medicare programs. It’s funded equally by the employer and employee. For 2021, each pays Social Security tax of 6.2% on the first $142,800 of an employee’s wages and 1.45% on all wages. Each year, the wage base (the maximum earnings subject to Social Security tax) is adjusted for inflation. Self-employed taxpayers will pay both the employer and employee portion but they’ll receive a deduction on their tax return for the employer portion.
Federal unemployment tax (FUTA) is paid by the employer and provides benefits to workers who become unemployed through no fault of their own. In 2021, the tax rate is 6% on the first $7,000 of each employee’s salary. Credits for paying state unemployment tax on time are available and can reduce this rate significantly.
THERE’S MORE
Some employees will have to pay the Additional Medicare tax depending on their tax filing status and their taxable income. Employers need to withhold this tax from pay checks for employees who earn more than $200,000 a year. The tax rate for 2021 is 0.9% of the excess wages.
GET FIT
Federal income tax (FIT) is taken out of an employee’s pay to cover their annual tax liability. How much taken out is based on information from the employee’s Form W-4, which they should fill out when they start a new job or anytime their circumstances change that might impact how much tax they owe.
FILE & PAY
The most common payment frequencies are monthly or semi-weekly. However, quarterly or annual payments are allowed for FUTA.
Quarterly payroll tax returns are needed for FICA, FIT, and the Additional Medicare tax. FUTA returns will be filed quarterly or annually, depending on your payment frequency.
IN A STATE
Payroll taxes extend beyond the federal level to the state level. Depending on your state, you may have to withhold state income tax from employees’ paychecks. And all states have an unemployment tax that employers pay. Some cities have payroll taxes too.
If your small business is planning for payroll next year, be aware that the “Social Security wage base” is increasing.
The Social Security Administration recently announced that the maximum earnings subject to Social Security tax will increase from $137,700 in 2020 to $142,800 in 2021.
For 2021, the FICA tax rate for both employers and employees is 7.65% (6.2% for Social Security and 1.45% for Medicare).
For 2021, the Social Security tax rate is 6.2% each for the employer and employee (12.4% total) on the first $142,800 of employee wages. The tax rate for Medicare is 1.45% each for the employee and employer (2.9% total). There’s no wage base limit for Medicare tax so all covered wages are subject to Medicare tax.
In addition to withholding Medicare tax at 1.45%, an employer must withhold a 0.9% additional Medicare tax from wages paid to an employee in excess of $200,000 in a calendar year.
Employees working more than one job
You may have employees who work for your business and who also have a second job. They may ask if you can stop withholding Social Security taxes at a certain point in the year because they’ve already reached the Social Security wage base amount. Unfortunately, you generally can’t stop the withholding, but the employees will get a credit on their tax returns for any excess withheld.
Older employees
If your business has older employees, they may have to deal with the “retirement earnings test.” It remains in effect for individuals below normal retirement age (age 65 to 67 depending on the year of birth) who continue to work while collecting Social Security benefits. For affected individuals, $1 in benefits will be withheld for every $2 in earnings above $18,960 in 2021 (up from $18,240 in 2020).
For working individuals collecting benefits who reach normal retirement age in 2021, $1 in benefits will be withheld for every $3 in earnings above $46,920 (up from $48,600 in 2020), until the month that the individual reaches normal retirement age. After that month, there’s no limit on earnings.
Contact us if you have questions. We can assist you with the details of payroll taxes and keep you in compliance with payroll laws and regulations.
I own a small company and want to reward my employees during the holidays. What can I do for them without triggering a tax issue?
ANSWER:
All forms of compensation are subject to income tax unless specifically exempted. So items like gift cards, savings bonds, and gift certificates are all reportable as taxable income on the employee’s W-2. You’ll also need to do the appropriate withholding and pay payroll taxes on this money.
Follow the Rules To completely avoid triggering any tax issues for your employees don’t gift cash and cash equivalents. Understand the de minimis rules which apply to gifts that are minor, of low value, infrequent, and administratively impracticable to track and report. Benefits that meet these requirements are generally not reportable as income.
The IRS does not identify any specific value as qualifying for de minimis treatment. Instead, the IRS looks at the overall nature of the gift, bonus, prize, or perk. Holiday gifts are generally okay if the value is so low that accounting for it is unreasonable or impracticable.
Bottom Line You can probably provide a reasonable holiday dinner, lunch or party for your employees without reporting it as income – as long as it’s not a common or recurring event. The same goes for holiday gifts like flowers and gift baskets of modest value.
The CARES Act’s new Employee Retention Credit is an alternative to receiving a loan through the Paycheck Protection Program (PPP). Businesses may choose the credit or PPP loan, if available. Unlike the PPP, the tax credit does not have a limit on the size of your business, making it an option for larger companies that don’t qualify for the PPP.
The Employee Retention Credit helps businesses to retain employees during the current economic crisis. The credit equals 50% of qualified wages and qualified allocable health care expenses paid to staff members between March 12, 2020 and December 31, 2020. The maximum credit per employee is $5,000 per quarter during that period.
In order to be eligible for this credit, however, the IRS states you must meet one of two qualifying factors. The first is if your operations have been suspended in any way because of the government’s restrictions on commerce, travel, or group meetings due to COVID-19. The other eligibility factor is if you experience a “significant decline” in gross receipts for the quarter. The IRS defines a significant decline as gross receipts totaling less than 50% than what they were in the same quarter for 2019. Once gross receipts reach 80% of the previous year’s quarterly numbers eligibility for any credit ends.
The employer is not required to pay qualified wages if they qualify for the program, and can choose to opt out of claiming the Employee Retention Credit.
One of the most laborious tasks for small businesses is managing payroll. But it’s critical that you not only withhold the right amount of taxes from employees’ paychecks but also that you pay them over to the federal government on time.
If you willfully fail to do so, you could personally be hit with the Trust Fund Recovery Penalty, also known as the 100% penalty. The penalty applies to the Social Security and income taxes required to be withheld by a business from its employees’ wages. Since the taxes are considered property of the government, the employer holds them in “trust” on the government’s behalf until they’re paid over.
The reason the penalty is sometimes called the “100% penalty” is because the person liable for the taxes (called the “responsible person”) can be personally penalized 100% of the taxes due. Accordingly, the amounts the IRS seeks when the penalty is applied are usually substantial, and the IRS is aggressive in enforcing it.
Responsible persons
The penalty can be imposed on any person “responsible” for the collection and payment of the taxes. This has been broadly defined to include a corporation’s officers, directors, and shareholders under a duty to collect and pay the tax, as well as a partnership’s partners or any employee of the business under such a duty. Even voluntary board members of tax-exempt organizations, who are generally exempt from responsibility, can be subject to this penalty under certain circumstances. Responsibility has even been extended in some cases to professional advisors.
According to the IRS, being a responsible person is a matter of status, duty and authority. Anyone with the power to see that the taxes are paid may be responsible. There is often more than one responsible person in a business, but each is at risk for the entire penalty. Although taxpayers held liable may sue other responsible persons for their contributions, this is an action they must take entirely on their own after they pay the penalty. It isn’t part of the IRS collection process.
The net can be broadly cast. You may not be directly involved with the withholding process in your business. But let’s say you learn of a failure to pay over withheld taxes and you have the power to have them paid. Instead, you make payments to creditors and others. You have now become a responsible person.
How the IRS defines “willfulness”
For actions to be willful, they don’t have to include an overt intent to evade taxes. Simply bowing to business pressures and paying bills or obtaining supplies instead of paying over withheld taxes due to the government is willful behavior for these purposes. And just because you delegate responsibilities to someone else doesn’t necessarily mean you’re off the hook.
In addition, the corporate veil won’t shield corporate owners from the 100% penalty. The liability protections that owners of corporations — and limited liability companies — typically have don’t apply to payroll tax debts.
If the IRS assesses the penalty, it can file a lien or take levy or seizure action against the personal assets of a responsible person.
Avoiding the penalty
You should never allow any failure to withhold taxes from employees, and no “borrowing” from withheld amounts should ever be allowed in your business — regardless of the circumstances. All funds withheld must be paid over on time.
If you aren’t already using a payroll service, consider hiring one. This can relieve you of the burden of withholding and paying the proper amounts, as well as handling the recordkeeping. Contact us for more information.
If federal income tax and employment taxes (including Social Security) are withheld from employees’ paychecks and not handed over to the IRS, a harsh penalty can be imposed. To make matters worse, the penalty can be assessed personally against a “responsible individual.”
If a business makes payroll tax payments late, there are escalating penalties. And if an employer fails to make them, the IRS will crack down hard. With the “Trust Fund Recovery Penalty,” also known as the “100% Penalty,” the IRS can assess the entire unpaid amount against a responsible person who willfully fails to comply with the law.
Some business owners and executives facing a cash flow crunch may be tempted to dip into the payroll taxes withheld from employees. They may think, “I’ll send the money in later when it comes in from another source.” Bad idea!
No corporate protection
The corporate veil won’t shield corporate officers in these cases. Unlike some other liability protections that a corporation or limited liability company may have, business owners and executives can’t escape personal liability for payroll tax debts.
Once the IRS asserts the penalty, it can file a lien or take levy or seizure action against a responsible individual’s personal assets.
Who’s responsible?
The penalty can be assessed against a shareholder, owner, director, officer, or employee. In some cases, it can be assessed against a third party. The IRS can also go after more than one person. To be liable, an individual or party must:
Be responsible for collecting, accounting for, and paying over withheld federal taxes, and
Willfully fail to pay over those taxes. That means intentionally, deliberately, voluntarily and knowingly disregarding the requirements of the law.
The easiest way out of a delinquent payroll tax mess is to avoid getting into one in the first place. If you’re involved in a small or medium-size business, make sure the federal taxes that have been withheld from employees’ paychecks are paid over to the government on time. Don’t ever allow “borrowing” from withheld amounts.
Consider hiring an outside service to handle payroll duties. A good payroll service provider relieves you of the burden of paying employees, making the deductions, taking care of the tax payments and handling recordkeeping. Contact us for more information.
