Many small business owners have never heard of trust fund taxes until they receive a Proposed Assessment of Trust Fund Recovery Penalty. These are the Social Security, Medicare and income tax employers withhold from their employees’ paychecks “in trust” for the federal government. Social Security and Medicare make up what’s often referred to as FICA or the Federal Insurance Corporations Act. The current tax rate for social security is 12.4% of wages and 2.9% of wages for Medicare, totaling 15.3%. The employer must pay half of this or 7.65% and the employee pays the second half. Under most circumstances, the employer withholds the employee’s half from his or her paycheck and remits the entire amount to the IRS. Most employees also have their income tax withheld directly from their paycheck and their employers remit that tax on their behalf directly to the IRS. Any differences between the amounts withheld and the amounts owed by the employee are settled up when the employee files his or her tax return.
This works just fine unless the employer fails to remit the amounts it has withheld from employee paychecks in trust for the federal government. When that happens, it is especially infuriating for the federal government, because that money was not the employer’s money to begin with and has effectively been stolen. In order to improve the IRS’s chance of collection, the law allows the government to hold business owners personally responsible for trust fund taxes, so feigning a bankrupt company will not get a business owner off the hook.
The penalties are steep too. Failure to deposit (after 10 days) is 15% of the amount outstanding. Failure to pay is 1.5% and failure to file the associated tax return (IRS Forms 941 or 944) is 23.5%. That’s a combined whopping 40% in penalties in addition to the underlying amount outstanding.
Since employers hit with unpaid trust fund taxes and the applicable penalties are in for such a ride, it behooves business owners to take precautions. Sometimes this happens to employers who routinely pay their employees in cash. Some business owners seem to think that cash transactions help their business stay off the government’s radar. This usually backfires though, because there are countless ways for auditors to reconcile your business activities and, if something doesn’t add for them, they will hound you until they feel their claim has been satisfied. It’s much better to think of recordkeeping as a value-added activity for your company, so you can prove its integrity, solvency and profitability to anyone who may have an interest in your company, such as creditors, investors and, of course, the government. You want to be sure of how money moves in and out of your business, so you can easily answer questions from any of these interested parties. It’s too time-consuming, stressful and expensive to plan on simply adopting a crisis mentality if and when you’re subjected to an audit or other inquiry.
Another reason why this happens is because there are numerous companies that offer payroll services and they’re not all scrupulous. It’s usually worth it for small business owners to pay a payroll company rather than prepare their own reports. However, it’s irresponsible to ignore your payroll operation altogether simply because you’ve outsourced that work. Your payroll company should be withdrawing funds directly from your bank account for trust fund taxes. Make sure you compare that to the amount reported on IRS Form 941 or 944 and Form NYS-45. Your payroll company should also instruct you to have all your employees sign a notice of acknowledgment of Pay Rate and Payday. This is a New York State form designed to register every employee’s pay rate and pay date to help prove theft of wages by payroll companies, because this has been a problem in the past. If they don’t provide this form to you, ask about it.
If you are a business owner unfortunate enough to be assessed a trust fund recovery penalty, I can help negotiate an installment agreement or offer-in-compromise with the IRS. I can also evaluate the effectiveness of your payroll company or internal payroll operation and make recommendations to help prevent a similar situation from arising again.