The Perils Of Payroll Taxes

The following article is reprinted with the permission of Nation's Business magazine. Nation's Business serves as a resource to the owners and top managers of small businesses (fewer than 100 employees) by providing practical, how-to information about running and growing a business. To subscribe to Nation's Business, call 1-800-210-8149.

By Gloria Gibbs Marullo

Payroll taxes rarely surface as an issue for public debate. But for business, they're a serious matter. Thousands of companies go under each year when the Internal Revenue Service demands payment of late payroll taxes.

``Payroll taxes represent a significant portion of the IRS's accounts receivable,'' says Carolyn Stumpf, a spokeswoman for the agency. ``Actually, we prefer to call them trust funds to emphasize that taxes withheld from employees' checks are entrusted to employers to deposit with the IRS. Some businesses, especially financially strapped companies, mistakenly think of withheld taxes as their money.''

Employers must pay to the IRS an amount equal to 15.3 percent of an employee's wage income of up to $62,700--half from the employee and half from the employer--to cover Social Security and Medicare taxes. (Together these are known as FICA taxes, for the Federal Insurance Contributions Act.) On all income above $62,700, employers must withhold 2.9 percent--again divided equally between employer and employee--for Medicare taxes. The employer also pays federal unemployment taxes (called FUTA taxes, for the Federal Unemployment Tax Act) equal to 6.2 percent of the first $7,000 of each employee's wages.

Depending on the amount of payroll tax funds you deposit with the IRS, your deadline for filing those taxes can be quarterly, monthly, semiweekly, or the day after payday when the total amount exceeds $100,000. No matter what your deadline, being one day late could subject you to IRS scrutiny and eventual penalties.

Late payroll-tax returns can trigger a series of notices and telephone calls from the IRS. If those attempts fail to resolve the matter, an agent will visit you and review your assets and liabilities. If the agent determines that your business is in a temporary slump, you can work out a payment plan for the taxes due.

What if your business is in serious trouble? ``The IRS must be paid before other creditors,'' says Stumpf. ``If all else fails, we will sell your assets to collect the taxes.''

An IRS public notice of sale is as close as you come to a business obituary. While Stumpf says the IRS is sympathetic with delinquent business owners, she adds: ``Lots of times the business is already bankrupt, but the owner is in denial. We make the difficult decisions the owner doesn't want to face.''

Losing a business is bad enough, but things can get worse. If the IRS determines that a ``responsible person'' of the company willfully paid other creditors before paying Uncle Sam's payroll taxes, that person can be personally assessed a penalty of 100 percent of the back taxes. A responsible person could be an officer or employee of the corporation, an outside accountant, or someone who signs checks for the business.

In a recent court case, the owner of a small airline on American Samoa was forced to resign as a company officer when the Federal Aviation Administration revoked the company's certification as a result of a number of serious violations. A financial manager carried on the day-to-day operations while the carrier struggled to regain certification and failed to pay payroll taxes. It was unclear whether the owner knew of the problem.

In a lawsuit that developed from IRS enforcement action, the court decided that the owner was personally liable for the 100 percent penalty because he retained control of the company's bank account.

There are no breaks for small businesses. If you are a one-person corporation, you are in the unique position of being your own boss and your own employee. When you pay yourself a salary from the corporation, you have the same payroll-tax liabilities and responsibilities as a 100-person corporation.

Companies operated as one-person sole proprietorships, however, escape much of the payroll-tax paperwork. If you are self-employed, you probably make quarterly estimated tax payments. At the end of the year, you file a Schedule C form, titled Profit or Loss From a Business, with your federal income-tax Form 1040 and pay self-employment tax (the sole proprietor's version of Social Security and Medicare taxes) on Schedule SE.

Life changes when you hire your first employee. While you continue to file Schedules C and SE to report your personal payroll taxes, you must also set up a system to withhold and deposit payroll taxes for the new employee.

Is the IRS more lenient with new businesses? ``Not really,'' says Stumpf. ``We try hard to educate small-business owners through free seminars and publications on payroll-tax requirements before they start their businesses.''

What if they missed the seminar? ``Let's face it,'' says Stumpf. ``We've all been an employee at one time and had payroll taxes withheld. Common sense tells you that if you have employees, you need to withhold and remit trust funds.''

In addition to withholding for federal income taxes as well as Social Security and Medicare taxes, businesses must pay federal unemployment taxes, or FUTA taxes. Any state unemployment-tax rate applied to you is subtracted from the 6.2 percent federal rate, up to 5.4 percent. If you qualify for the full 5.4 percent credit, your FUTA tax rate could be reduced to 0.8 percent. FUTA taxes are paid to the IRS once a year when you file Form 940, Employers Annual Federal Unemployment Tax Return.

Federal payroll taxes are just the beginning. Most states have their own income taxes, and in recent months a growing number of cities and counties have passed local income-tax laws.

States' employment-security divisions also have varying rates and wage bases for state unemployment taxes. Together, the federal, state, and local payroll-tax requirements can turn into a nightmare of deadlines, deposits, tax returns, penalties, rate changes, and reconciliations.

Help is around the corner, though. For do-it-yourself types, there's software such as DacEasy Accounting & Payroll, from DacEasy Inc.; Peachtree Accounting, from Peachtree Software; QuickBooks, from Intuit; and Simply Accounting, from Computer Associates International. Or you can pay your CPA to handle the paperwork.

Another option many small firms turn to is payroll accounting services. These print employees checks, make the payroll-tax deposits, and handle the federal and state reporting requirements.

At what point does it make sense for a business to use outside help? Even small firms can afford a payroll service. Says Doug Schwab, sales director in Chandler, Ariz., for ADP, a nationwide payroll service: ``In the Phoenix area, our EasyPay service has 3,000 clients, and the average number of employees is eight. In our experience, you're never too small to get help.''

Rates vary across the country, but a company with one employee in Phoenix would pay $16 for ADP to process each weekly payroll, says Schwab. If the same company employed 10 people, the total cost would be $30.18, and a weekly payroll for 50 people would cost $68.50.

What should you be doing about payroll taxes? If you have an in-house payroll department, give your payroll people the training they need to stay on top of constantly changing rates and requirements. If you use a payroll service or a CPA, make sure your company monitors the payroll-tax reporting.

Finally, if you're ready to bring payroll in-house or plan to start a business and want to go it alone, call the IRS at 1-800-TAX-FORM (1-800-829-3676) and sign up for a free seminar on employers' trust-fund responsibilities.

While you're on the phone, ask for a copy of Publication 15, Circular E (Employers Tax Guide) and Publication 15A (Employer's Supplemental Tax Guide). You'll need them.