Over two-thirds of the tax revenues collected by the IRS come from deductions from employee paychecks—withheld income tax and FICA taxes. (FICA stands for Federal Insurance Contributions Act, the principal funding source for Social Security and Medicare). These taxes are sometimes referred to collectively as Employment Taxes, or Payroll Taxes. Given their vital importance to the federal budget, it should come as no surprise that any time the IRS deems that these withheld taxes are not being fully paid into the federal treasury in a timely manner, it responds swiftly and harshly.
The Principle of Withholding Taxes
The most important thing for all employers to bear in mind is that the operative part of the word “withhold” is hold. When payroll taxes are deducted from an employee’s wages, the company is simply holding the money until the appropriate time to relinquish the funds to the federal treasury. Many companies are required to make quarterly payments to the IRS, but depending on the size and structure of your company, the timetable for your payments may be different.
What this all means is that the employer is simply acting as an intermediary, managing the transfer of funds from the workers who owe taxes to the agencies that collect them. At no point does a single penny retained through paycheck deductions for federal and state taxes belong to the employer, any more than holding a friend’s purse while she uses the restroom grants you ownership of its contents.
Most employers understand these rules, but when times are tough and revenues are insufficient to make this month’s payroll or pay the mortgage, it can be tempting to dip into the reserve of withheld employment taxes to keep the business running. Very few company leaders make the decision to borrow from this accumulated trust lightly or with ill intent. Most of them genuinely believe that business will soon pick up, and fully intend to replenish the trust when it does. Yet the consequences of failure to pay withheld taxes to the IRS in full and on time are far too severe to justify ever taking such a risk.
The 100% Penalty and Responsible Parties
The primary weapon the IRS wields to enforce laws governing payment of withheld taxes is known as the “100% Penalty,” because the penalty amount exactly equals the withheld taxes that the employer has failed to turn over to the U.S. Treasury. This penalty may be assessed to any responsible party within the organization—that is, anyone involved in making the decision or executing the process that led to late payment or non-payment of the taxes to the IRS. There are two vitally important aspects of this penalty that all business owners must bear in mind:
1. A “100%” penalty often amounts to 200%, 300% or more in the end.
The so-called 100% penalty may be assessed on any and all responsible parties, which means that the IRS can and does assess the penalty multiple times for the same offense by targeting different individuals within the organization.
2. Individual assets of responsible parties are at risk.
The 100% penalty is, legally, a penalty assessed to an individual, not to the company as a whole. As a result of that formulation of the rules, the IRS has the authority to go after the personal assets of anyone identified as a responsible party. The usual protection of such assets offered by corporate or LLC status does not apply.
Criminal Penalties
Furthermore, monetary penalties might be only the beginning of an employer’s woes. Federal statutes define employer failure to surrender withheld taxes to the national treasury as a criminal offense. In essence, the use of employment tax trust funds for any purpose other than simply forwarding the money to the IRS constitutes a crime no matter what perspective you view it from. From the perspective of employees, their money has been stolen; from the perspective of the U.S. Treasury, its funds have been embezzled by someone entrusted with the job of safeguarding them.
The possibility that criminal prosecution and resulting fines or even jail time will follow swiftly on the heels of assessment of the 100% penalty is more real today than ever before. In recent years, the IRS has clearly expressed an intention to broaden its criteria for referring payroll tax noncompliance cases for criminal prosecution.
Get Out in Front of Employment Tax Problems
If your company is struggling and the only way out of the hole appears to be dipping into withheld tax reserves, seek the guidance of a qualified financial consultant and your tax advisor immediately. Do not make the mistake of grasping at what appears to be the easy way out of the bind. The consequences of noncompliance with laws governing payroll tax withholding could make both your business and your personal life anything but easy for a long time to come.
