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The Risk Associated With Misclassified Employee

This Article Is Authored By MSI Global Talent Solutions

Unpaid payroll tax penalties are fines imposed by the Internal Revenue Service (IRS) on employers who fail to collect, report, and repay payroll taxes.

Important Takeaways

  • Employers must withhold income tax, Social Security tax, and Medicare tax from their workers' paychecks and record and submit these amounts to the IRS.

  • Employers must also match withheld Social Security and Medicare taxes and pay these amounts to the IRS.

  • When employers intentionally violate these rules, the IRS applies monetary penalties ranging from 2% to 100% of the unpaid tax, depending on the kind of tax.

  • Penalties might be imposed even if you are just late with your payments.


What Are the Penalties for Unpaid Payroll Taxes?

In IRS Publication 15, the IRS outlines various obligations and penalties for failing to complete payroll responsibilities, although some are more prevalent than others.

The most common mistakes involve Form 941 taxes (withholding and FICA), although some also apply to other related forms.

  • Failure to submit Form 941 and comparable forms will result in a 2% penalty if you are one to five days late, a 5% penalty if you are six to 15 days late, and a 10% penalty if you are 16 days late or less than 10 days after receiving your first warning from the IRS. The maximum penalty is 15% for sums not paid within 10 days of receiving your first IRS letter regarding the tax payable.

  • Failure to deliver information returns to workers, such as Forms W-2, as well as other payees on Form 1099-MISC, may result in IRS fines.

  • Failure to pay payroll taxes on time results in a trust fund recovery penalty (TFRP).

Note

Deposits are applied to the most current responsibility, so a warning t the wise, “don't be late with them.”


How Do Penalties For Unpaid Payroll Taxes Work?

Assume you are obliged to pay a monthly deposit of $1,500. You don't make your March 15 deposit, but you make a $2,000 deposit on April 15 to make up for it. Because $1,500 of that payment is applied to April 15 and $500 to March 15, you may be penalized for the $1,000 that was not paid on March 15.

If you misclassify workers as independent contractors, you may face penalties for missed payroll taxes. You are not required to withhold income taxes or FICA taxes from payments given to independent contractors, but you may incur penalties if the IRS determines that they were misclassified and should have been paid as employees because they did not meet the independent contractor qualifying standards.


Payroll taxes are a kind of trust fund tax.

Trust fund taxes are those that are collected from someone, usually a client or an employee, and then kept "in trust" by a company until they are passed over to the proper taxing agency. The most frequent forms of trust fund taxes are sales taxes and payroll taxes.

When a firm fails to make timely payments, the IRS has the authority to levy the trust fund recovery penalty. The IRS may apply the TFRP for willful:

  • Non-collection of taxes

  • Failure to report and pay taxes

These "willful" conditions must be met, and the failure must be committed by a person that was accountable for the failure. Willful is defined by the IRS as "voluntarily, deliberately, and purposefully."

Note

Willfulness may be shown in certain situations by a careless disregard for evident facts.


Payroll Taxes and Their Varieties

  • Federal income taxes: These must be deducted from employee pay and paid to the IRS in accordance with the law.

  • Social Security and Medicare taxes: Also known as "FICA taxes," they are required to be deducted from employee pay and matched by employers.

  • Federal unemployment taxes: These must be paid by the company and are calculated based on the total gross salary of all workers.

  • State unemployment taxes: These must be collected, recorded, and paid in accordance with state regulations.

Assume a corporation has multiple workers and withholds $5,000 in federal income tax and $2,000 in FICA tax from all employee paychecks on one payday.

  • The IRS must be paid the $5,000 in federal income tax.

  • The $2,000 in FICA tax must be paid to the IRS for the Social Security Administration, along with an extra $2,000 in FICA taxes owed by the employer.

The corporation should account for withheld employment taxes and make payments to the IRS when they are due.


Questions and Answers (FAQs)

What is the penalty for failing to pay FICA taxes?

The penalty for failing to pay FICA and other employment taxes is determined by how late you were. They range from 2% for taxes paid one to five days late to 15% for taxes paid more than ten days after receiving your IRS notification regarding your outstanding tax debt.

What happens if you don't pay your payroll taxes on time?

If you file your payroll taxes late, you will be penalized depending on how late you paid your taxes. The fines vary from 2% to 15%.


The Future of Work

As the future of work continues to evolve, and new worker employment models emerge, companies must remain hypervigilant with regards to their payroll tax treatment and employee classification. Within the US, and particularly during the disruptive employment period during and following the Covid Pandemic many businesses lost skilled employees in their compliance and payroll divisions and with that the knowledge regarding withholding requirements for contract employees, and the steep penalties for make errors or being late with payments in this complicated area of tax and payroll and employment law


OUR EXPERTISE:

MSI’s Tax specialists work with organizations to perform an up to date tax and payroll review to be sure they are following compliant practices and are fully documented and prepared should they be chosen by the IRS for a federal or state tax audit. We often augment in house staff in catching up on their last three years of tax practices to be sure that compliance has been maintained, and to develop a plan in preparation for highly likely employee tax and payroll audits.

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