What Are the Consequences of Failure to Withhold or Pay Federal Taxes?

If you have employees, you’re required to withhold federal taxes from employee paychecks and remit this money to the government by the deadline, along with your portion of payroll taxes as the employer. Failing to do this can lead to pretty severe tax penalties and even criminal charges.

As a business owner, it’s a challenge to keep up with operations while also thinking about your tax obligations. That’s why many taxpayers get into deep water after failing to file a tax return, failing to pay their tax bill, or failing to withhold federal taxes.

Staying in compliance with tax law is a must; otherwise, you put your business at risk. This post provides the information you need about withholding and paying federal taxes as a business owner and the consequences you may face if you fail to do so.

What Is Failure to Withhold or Pay Taxes?

Failure to withhold is when an employer does not withhold the correct FICA and income taxes from their employees’ paychecks. Failure to pay refers to situations where employers don’t pay these taxes, whether they’re correctly withheld them or not.

Employers have specific obligations when it comes to taxes. You must withhold income taxes and Federal Insurance Contributions Act (FICA) taxes from employee wages. FICA taxes are Social Security and Medicare taxes.

Contractors, or people who work for themselves, aren’t considered employees, so you usually don’t have to withhold taxes from their pay. They are responsible for paying that amount themselves in their quarterly taxes.

Failure to withhold or pay taxes happens when you don’t withhold these taxes from employee paychecks and you don’t remit taxes to the government as required. There can be pretty significant fines against you if you fail to pay. If you’ve made an error, talk to a tax professional right away.

Legal and Financial Consequences

You or your business can get hit with both legal and financial consequences related to failure to withhold or pay taxes. Let’s look at each type of consequence:

• Legal consequences: You may be charged civil penalties and even criminal penalties and fines. If you’re willfully found to have evaded taxes, you could face prison time. The IRS could file a federal tax lien on your property as well.
• Financial consequences: Of course, having to pay penalties on top of the taxes you owe is significant for your business, and remember that you’ll also have interest building up on your outstanding balance.

These consequences are serious. The IRS expects you to withhold, file, and pay taxes according to the deadlines. When you don’t, you’ll have to pay even more.

Trust Fund Recovery Penalty

One penalty you need to be aware of is the trust fund recovery penalty, or TFRP. This penalty is issued against the person who was responsible for collecting and paying trust fund taxes (income and employment taxes) when they were not remitted by the due date.

The IRS investigates who should be held responsible by identifying who is in charge of collecting or paying income, employment, or excise taxes. They may face a TFRP assessment if they willfully failed to collect or pay the taxes.

A responsible person is likely an employee, officer, partnership member, director, board member, or other person who controls payroll tasks. To be found willful, they must have been aware of the outstanding taxes — or should have been — and they intentionally ignored tax law or were “plainly indifferent” to their tax requirements, per the IRS.

Avoid the TFRP at all costs. It is equal to the unpaid trust fund tax balance, so you essentially double your tax bill with this penalty.

Failure to Deposit Penalty

Another consequence to know is the failure to deposit penalty. If you don’t make your required employment tax deposits by the deadline, the IRS will assess this fee against you. The percentage used to calculate your penalty depends on how long you wait to pay after the deadline.

• If your deposit is one to five calendar days late, the penalty is 2% of the unpaid deposit.
• If your deposit is 6 to 15 days late, it’s 5%.
• If your deposit is more than 15 days late, it’s 10%.
• If your deposit is more than 10 days late after your first notice date or a notice for immediate payment, it’s 15%.

Remember that on top of this penalty, you’ll see interest accrue on your balance until it’s paid off. If you couldn’t meet your tax obligations because of a reasonable cause yet still acted in good faith, the IRS may agree to waive or reduce the penalty.

The Difference between Employee and Employer Taxes

Many people use the phrases payroll taxes and employment taxes interchangeably, and both usually refer to the taxes withheld from employee paychecks and the taxes the employer is responsible for. Here are how those two components differ:

• Taxes withheld from employee paychecks: Social Security and Medicare (FICA) and income tax (federal, state, local)
• Taxes the employer is responsible for: Social Security, Medicare, federal unemployment tax (FUTA), state unemployment tax (SUTA), and any applicable local taxes

So, employers contribute to FICA as well but are also on the hook for unemployment taxes. Employees are fully responsible for covering their income tax.

Best Practices for Tax Compliance

Penalties can be significant for failing to withhold or pay employment taxes on time. Ensure compliance by implementing these best practices:

File on Time

Most employers use Form 941, Employer’s Quarterly Federal Tax Return. This form must be filed by April 30, July 31, October 31, and January 31 to report wages paid and taxes withheld from the previous quarter.

Deposit Payroll Taxes on Time

Your payroll taxes aren’t due with your return. Usually, they are due much earlier. There are two deposit schedules: monthly and semi-weekly. The schedule you use depends on your total tax liability. If you had total taxes on Forms 941, line 12, for the four quarters of the year at $50,000 or under, you do monthly. If more than $50,000, you do semiweekly.

Monthly deposits must be made by the 15th of the month following the month of payments. Semiweekly deposits must be made by the following Wednesday if payments were made on Wednesday, Thursday, or Friday, and the following Friday if payments were made on Saturday, Sunday, or Monday.

If you ever have $100,000 of payroll tax payments that have accumulated, you must pay them the next business day regardless of whether you’re on a monthly or semi-weekly schedule.

Keep Accurate, Organized Records

It’s easy to fall behind on tax obligations or report incorrect information when you’re not organized and you don’t have strong payroll systems in place. Make sure you keep thorough payroll records so you can track employee payments and taxes withheld. 

Consider using a software or platform to help you log information and keep data accurate and updated. Keep documents secure and safe but ensure those who need them to prepare taxes can access them easily and understand the information.

Communicate with the IRS and Ask for Penalty Abatement

It can feel stressful to get a notice in the mail from the IRS. However, if you get one, read the instructions carefully. Contact the IRS using the information they provide if you don’t agree with the notice or you have questions. 

Never ignore an IRS notice or communication. This will only make your situation worse, whether with building penalties and interest or additional legal consequences. Talk to a tax professional for guidance on IRS communications. If you incur penalties for paying late, ask for penalty abatement.

Consider a Payment Plan

Many businesses may not be able to pay their bill in full by the deadline. If that’s the case, you have options. Reach out to the IRS about setting up a payment plan, also known as an installment agreement. In-operation businesses can get up to 24 months to pay some delinquent taxes, and you may be able to get longer if you are no longer in business.

Working with a Tax Professional

One of the best steps you can take when you get an IRS notice or can’t pay your tax bill is to talk to an expert. They will help you understand the violation or penalty and your options for recourse. 

Tax attorneys and certified public accountants (CPAs) can also help you understand tax compliance throughout the year, not just at tax time. If you have trouble with recordkeeping, don’t understand tax requirements, and are getting behind on employment taxes, work with a tax professional right away.

For example, consider a business office with over 100 employees. That is a lot of payroll and tax information to collect, store, and process. If the person responsible for payroll is used to entering everything into a spreadsheet and issuing tax forms to employees manually, it’s going to take a lot of time and leave plenty of room open for errors. This can get in the way of timely tax payments and accuracy. 

Working with a tax professional, this same business was able to incorporate software and embrace automation techniques, which speed things up and ensure accuracy. They also started relying on the CPA for tax questions that arise during the year, and they can rest assured that they’re staying tax compliant since an expert is keeping things in order.

Are There Preventive Measures to Avoid Payroll Tax Penalties?

The good news is that once you’re aware of your obligations and have the help you need, you can put better practices in place to ensure future compliance. Here are a few preventative measures:

• Regular internal audits: Reviewing your taxes and processes regularly will ensure you’re staying compliant. Audits also help you identify any errors or risks before they have negative impacts. 
• Employee education: Make sure you’re prioritizing employee education related to tax compliance. Training is an ongoing concern since one year could look different from the next. Keeping people informed allows them to prepare and avoid mistakes.
• Monitor changes in tax law: Tax regulations and requirements change frequently. Put systems in place to monitor changes and update policies accordingly. Stay ahead of any upcoming modifications.
• Bring in an expert: The best way to stay proactive against tax penalties is to work with a tax expert. Talk to someone familiar with the law to help you review your obligations and ensure you’re putting the right measures in place to comply.

Being proactive is a must with employment taxes. Remember that you can take steps right now to avoid tax issues in the future.

Avoid Employment Tax Penalties with Seattle Tax

If you’ve failed to withhold employment taxes or pay on time, the first thing to do is act fast. Pay attention to IRS notices, and never ignore them. Ask the IRS to waive a penalty if something got in the way of your ability to pay. Be proactive by keeping accurate records and reviewing them regularly.

Tax compliance doesn’t have to be such a headache. Work with a tax attorney or CPA for help. At Seattle Tax, we’re dedicated to protecting you and defending you from the IRS, whether you need help filing, tax representation, tax debt assistance, or penalty relief. 

Contact our team to learn more about how we can help your business comply with tax law.