What Is the IRS Failure to Deposit Penalty?
If you don’t make payroll tax deposits on time, the IRS can apply a failure to deposit penalty. This penalty is typically 2% to 10% of the tax payment due. However, it’s not the only penalty that may come into play, and if you have employees, it’s critical that you understand the rules related to payroll and business taxes.
Navigating tax law can be daunting, even for seasoned business owners. Among the myriad of obligations and regulations, one of the most critical is the requirement to withhold and pay federal taxes correctly. Missteps in these areas, particularly with payroll and income taxes, can lead to serious consequences, including severe penalties and potential criminal charges.
One essential aspect of fulfilling employment tax responsibilities is the filing of employment tax returns with the IRS. Another important element is making the necessary employment tax deposits on time, in the correct amount, and using the correct method of payment. Failure to meet any of these requirements can result in the Failure to Deposit Penalty.
An Overview of the Failure to Deposit Penalty
The Failure to Deposit Penalty (sometimes known as a 941 late payment penalty) is a penalty an employer has to pay for not making the required employment tax deposit on time, in the right way, or in the right amount. Typically, the penalty is 2% of the tax due, but first, let’s look at what’s an employment tax?
Employers are required to take out a portion of their employees’ compensation each pay period. The amounts typically withheld (for federal tax purposes) are the employees’ share of the FICA tax (Medicare and Social Security taxes) and the employees’ income taxes. Additionally, employers have to pay their share of the FICA, as well as the Federal Unemployment Tax Act (FUTA) tax which only employers pay not employees.
All of these make up the employment taxes that employers must collect and remit to the IRS on a set schedule, and if they’re late, the employer will incur a penalty.
Employment Tax Deposit Schedule for Employers
There are three main deposit dates to be aware of. First, taxes withheld from the employees’ paychecks (income and FICA) are paid either monthly or semiweekly (twice per week). Which schedule applies depends on the employer’s total tax liability during the applicable lookback period.
IRS Publication 15 can be used to help determine the lookback period and which type of depositor the employer is. Typically, if you reported $50,000 or less in tax for the last four quarters, you should use a monthly deposit schedule. If you reported over $50,000 in the last four quarters, you should use a semi-weekly deposit schedule. On either schedule, if you accumulate at least $100,000 in a deposit period, you must make a deposit the next business day.
Second, FUTA tax deposits are usually due by the last day of the first month that follows the end of the quarter. However, if the FUTA tax deposit amount is $500 or less in a quarter, then that amount carries over to the next quarter for payment. If your annual FUTA tax is less than $500 for the year, it’s due on January 31st following the year payments were made to your employees.
Due Dates for Payroll Taxes
If you’re a monthly depositor, your deposits are due on the 15th of the month following the month when payments are made. For example, the taxes you withhold from your employees’ January paychecks are due on February 15th.
Semi-weekly deposits are due on Wednesday for payments made on Wednesday, Thursday, or Friday of the previous week. If you make payments on Saturday, Sunday, Monday, or Tuesday, the deposit is due on Friday. Annual filers must pay by January 31st of the year following the year of payments.
On any schedule, you must pay the next business day if you accumulate more than $100,000 of payroll tax. To give you an example, say that you’re usually a monthly depositor, but you hire a lot of new employees and give current employees raises. You pay employees every Friday. On the third Friday of the month, you realize that your payroll taxes due for the next period have reached over $100,000. Now, instead of waiting until the 15th of next month to make your deposit, you must make it by the next business day which in this case is Monday. If you stick to your regular deposit schedule, you will incur a late deposit penalty.
How to Make Employment Taxes Deposits
The IRS requires employers to make their employment tax deposits through electronic funds transfers (ETF). This can be done in several ways, including the Electronic Federal Tax Payment System (EFTPS). Other ETF options exist, but they may charge a fee (EFTPS is free). Some of these alternative options include:
- Asking your bank to make an automatic clearing house (ACH) payment or same-day wire payment.
- Asking your tax professional to send payment for you.
- Using payroll software that automatically deposits the taxes after withdrawing them from your bank account.
If you fail to make these deposits using the necessary ETF method, the IRS will impose a Failure to Deposit Penalty.
How the IRS Calculates the Failure to Deposit Penalty Amount
The Failure to Deposit Penalty could apply in three situations. Situation one applies if you don’t use an ETF to send your deposit to the IRS. For example, instead of depositing your payment online, you mail a check with a paper return. The penalty here is 10% of the amount that should have been deposited using an ETF.
The second situation applies when you make your deposit payment with ETF but you do so late. The penalty increases as follows:
- 2% of the unpaid deposit if it’s one to five calendar days late.
- 5% of the unpaid deposit if it’s six to 15 calendar days late.
- 10% of the unpaid deposit if it’s more than 15 calendar days late.
Note that these are not cumulative penalties. For instance, if you send your deposit one week late, your penalty is 5%, not 7% (the 2% penalty is not added to the 5% penalty).
If you don’t send the full deposit amount, that’s when the third Failure to Deposit penalty situation arises. This penalty only applies to the unpaid amount. For example, if you had to pay $15,000 by March 30, but only paid $10,000 by that date, then your penalty would apply to the $5,000 that hasn’t been paid yet. The penalty percentage would then depend on when you pay the $5,000 in accordance with the above-referenced bulleted list.
Frequently Asked Questions About the Failure to Deposit Penalty
Do employers need to file special tax returns for employment taxes?
Yes. Most employers must file IRS Form 941, Employer’s Quarterly Federal Tax Return every quarter to report their employees’ income and FICA tax withholdings. This return is due by the last day of the month that follows the end of the quarter. So the first quarter Form 941 return is due by April 30.
However, if you anticipate owing less than $1,000 in payroll tax, you may qualify to file Form 944 once a year to report payroll taxes. You must note this preference when you apply for an EIN. Additionally, farmers and fishers use a special form for annual payroll taxes called Form 943.
You’ll also file IRS Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return once a year, with a due date of January 31.
Are there other penalties an employer could face for not properly paying employment taxes?
Yes. An employer that doesn’t properly make their employment tax deposits could be liable for the trust fund recovery penalty (TFRP). Not only is this penalty much larger than the Failure to Deposit Penalty (it’s 100% of the unpaid trust fund portion of the employment taxes), but it can also be imposed on any person who’s responsible for collecting and paying the employment taxes but intentionally fails to do so. This means someone could be personally liable for this penalty.
Criminal penalties are also possible in some cases where the failure to pay the employment taxes amounts to tax evasion (also known as criminal tax fraud). This could result in hundreds of thousands of dollars in fines plus up to several years in prison.
Does the IRS charge interest on the Failure to Deposit Penalty?
Yes, although the exact amount varies each quarter. Also, corporations of a certain size may face higher interest rates for unpaid taxes than small businesses with employees.
Will the IRS waive the Failure to Deposit Penalty?
Sometimes. The IRS is willing to remove or reduce this 941 late payment penalty if you acted in good faith and had reasonable cause for the late, incomplete, or improper payment. What the IRS accepts as reasonable cause depends on the specific facts and circumstances of your case and the reasonable cause(s) must apply to the individual responsible for sending the employment tax deposit to the IRS.
A Failure to Deposit Penalty waiver is also possible through First Time Abate. To be eligible for this waiver, you must have a history of good tax compliance. This usually means not receiving any penalties in the past three years or any penalty waiver you received was for a reason other than First Time Abate. In addition to good tax compliance, you’ll need to make sure four or more Failure to Deposit Penalty waiver codes aren’t present in the last three years and the Failure to Deposit Penalty isn’t charged for EFTPS avoidance.
In some cases, the IRS will agree to not apply the penalty if you don’t have a bank account and were unable to get one despite trying.
Can I dispute the Failure to Deposit penalty?
If you disagree with the imposition of the penalty or its amount, you can contest it with the IRS in one of two ways. First, you can call the toll-free number located at the top right of the letter or notice the IRS sends you. Alternatively, you can write a letter to the IRS identifying the letter or notice you’re responding to, the penalty you want to dispute, and the reasons for disputing it. You’ll also need to sign the letter and include any documents in support of your arguments.
How will I know if I have to pay a Failure to Deposit Penalty?
You will receive a notice or letter from the IRS indicating you owe the Failure to Deposit Penalty. These might include a CP220 Notice or a CP504J Notice.
Do You Need Guidance Dealing With a Late Payroll Tax Penalty?
The Failure to Deposit IRS penalty can be frustrating to deal with. But if you get hit with this penalty, you might not fully understand why or what you can do to avoid it in the future. Or perhaps you feel there are extenuating circumstances that warrant a penalty waiver. If you find yourself in any of these or similar situations, contact Seattle Legal Services, PLLC. You can call us at 425-428-5262 or use our online contact form to set up a free initial consultation.