Payroll tax penalties are an avoidable business expense, yet, each year, many organizations fall prey to them. This is largely due to incorrect calculations, missed deadlines and improper reporting. Employers can minimize these expensive mistakes with a meticulous payroll process, but as their business grows in size and requirements become more complex, working with a payroll provider may be a better way to support compliance.
Table of Contents
What are unpaid payroll tax penalties?
Payroll tax penalties, more properly known as employment tax penalties, are penalties imposed by government agencies on employers who don’t fulfill their tax responsibilities. The most common is the failure to deposit penalty, which applies when employers fail to deposit their owed employment taxes on time.
If employers willfully fail to collect or deposit employment taxes, the government may also impose a Trust Fund Recovery Penalty (TFRP). It carries a much harsher penalization rate than the failure to deposit penalty and could potentially subject employers to additional consequences, including criminal charges.
What payroll taxes are you required to pay?
Employers are required to withhold and pay all employment taxes that apply to their business. This may include income taxes, Federal Insurance Contribution Act (FICA) taxes and unemployment taxes, among others.
FICA taxes and Form 941
Employers must withhold FICA taxes, also known as Social Security and Medicare taxes, from employee wages and pay an employer portion (up to the Social Security wage base). Payment schedules vary with payroll size, but FICA taxes are commonly paid monthly or semi-weekly and are reported quarterly using IRS Form 941, Employer's Quarterly Federal Tax Return.
Federal and state income taxes
The IRS, most state governments and some municipalities require employers to withhold income tax from their employees’ wages. Like FICA taxes, federal income taxes are due monthly or semi-weekly and are reported quarterly using Form 941. Due dates and reporting methods for state and local income taxes vary by location.
Federal unemployment taxes and Form 940
Businesses that pay $1,500 or more to employees in any one quarter or have one or more employees for 20 or more weeks in a year generally must pay federal unemployment tax. These payments may be made quarterly or annually, depending on how much is owed. In either case, businesses must file IRS Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return at the end of the year
State unemployment taxes
Employers typically pay state unemployment tax in every state where they have employees. In most cases, payments are due quarterly, but the rates and wage bases vary by location. A business’s particular industry and previous experience with unemployment claims may also affect its unemployment tax liability.
Furnishing employee wage and tax reporting forms
Failing to accurately complete wage and tax reporting forms or missing distribution deadlines can result in monetary penalties. For example, businesses are required to send Form W-2, Wage and Tax Statement to employees and Form 1099-NEC, Nonemployee Compensation to independent contractors by January 31 of the following tax year.
Switching payroll providers made easy
Download NowHow to calculate payroll taxes
The IRS charges a flat rate for employment taxes. Employers withhold 6.2% of employee gross wages for Social Security (until the wage base is reached) and 1.45% for Medicare. Combined, the total is 7.65%, which the employer must match. There is also an Additional Medicare Tax of 0.9% that applies to employee income above a certain threshold.
In addition, income tax may have to be withheld from employee wages each pay period. It is calculated based on appropriate tax withholding certificates submitted by employees and current federal, state and local income tax brackets.
Lastly, there are unemployment taxes, which vary by jurisdiction. Employers pay 6% federal unemployment tax on the first $7,000 of each employee’s wages, but may qualify for a credit up to 5.4% if they pay applicable state unemployment taxes.
Penalties for not depositing and reporting payroll taxes
Businesses that fail to comply with employment tax laws may be subject to:
- Monetary penalties
- Interest due on back taxes
- Liens against property
- Civil penalties
- Criminal prosecution
How much will an employment tax penalty cost?
The cost of employment tax penalties usually depends on several factors, including the type of infraction, the size of the business, how much is owed and whether payment was late or never received.
For example, failure to deposit penalties impose a specific penalty rate, which increases the longer that payments are past due. The chart below demonstrates the applicable penalty rates for late payments:
| Days Late | Tax Penalty |
|---|---|
| 1 to 5 days | 2% |
| 6 to 15 days | 5% |
| 16+ days | 10% |
| 10+ days after the first IRS notice | 15% |
How do payroll tax penalties work?
Failure to deposit penalties are typically applied after the IRS receives a late payment. In most cases, the agency will issue a notice to the taxpayer’s address of record, stating the penalty amount and due date. It will also include the amount of interest charged to the employer’s account if the penalty is paid timely.
TFRP is applied when the IRS determines that there is willful failure, i.e., the employer was or should have been aware of outstanding taxes and either intentionally disregarded the law or was indifferent to its requirements. A common example is when a business has the funds to reimburse other creditors, but neglects to pay employment taxes. In such instances, the IRS will issue a notice to the employer explaining why the TFRP has been applied. They may also give the employer a chance to challenge the penalty.
Penalty relief
Businesses that receive a penalty notice may be able to seek abatement. In cases of TFRP, the IRS may abate the penalty if the employer proves they did not act willfully and had reasonable cause for the unreported taxes or the late payments. Typical reasons can include:
- Fires and natural disasters
- An inability to obtain records
- Death and serious illness
- Unavoidable absence of the taxpayer or immediate family
Note that a lack of funds, in and of itself, is not considered reasonable cause. Employers must also provide documentation, such as a letter from a physician, a hospital or court record, or physical evidence of a disaster.
How to avoid payroll tax penalties
Employers can avoid employment tax penalties by improving their payroll processes so that all compensation paid to employees and all taxes withheld from wages are deposited and reported to government agencies on time. This is easier said than done, but the following guidance may help:
Stay up to date with IRS announcements
The IRS regularly publishes news releases and tips that can help employers learn about updates to tax laws and new form submission deadlines. Businesses should also pay close attention to tax announcements in all states where they employ people.
Keep an employment tax budget
Failing to include payroll costs when planning a budget can lead to cash shortages and an inability to pay taxes. That’s why many businesses maintain a separate bank account just for payroll expenses, which helps them better manage their tax withholdings and deposits.
Use a payroll provider or full-service payroll software
Employers who want to reduce their tax penalty risk and have more time to focus on strategic business initiatives often automate payroll processing. Full-service payroll providers, like ADP, can assist with calculating employee wages, withholding the necessary taxes from employee wage payments, calculating the employer tax amounts, and depositing and reporting all tax amounts to government agencies on the business’s behalf. As a result, clients using a payroll provider that offers tax filing services often rest easy knowing their wage and tax payments are both accurate and timely.
See how simple small business payroll can be
Compare PackagesFrequently asked questions about payroll tax penalties
What happens if you cannot pay payroll taxes?
Businesses that are unable to pay their employment taxes usually receive a notice from the IRS and a monetary penalty. If the taxes remain unpaid and the failure is determined to be willful, the IRS can place liens on employers’ assets or file criminal charges against them.
Who is liable for unpaid payroll taxes?
Anyone who is tasked with collecting depositing and reporting employment taxes, such as an accountant or executive leader, may be held responsible for infractions.
Will the IRS negotiate payroll taxes?
Under certain circumstances, employers who are unable to pay their employment taxes can settle their tax debt with the IRS for less than the full amount owed. To apply, they must submit Form 656, Offer in Compromise and all supporting documents that prove their eligibility.
Is not paying payroll taxes a crime?
If the IRS determines that an employer willfully neglected to pay employment taxes, the individual could face civil penalties and criminal prosecution, including imprisonment for up to five years.
This article is intended to be used as a starting point in analyzing an employer’s payroll obligations and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.
