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The IRS estimates that 40 percent of small to medium-size businesses in the United States end up paying a payroll penalty each year for failing to deposit withholdings, depositing the wrong amount of withholdings, or for incorrect filing. In the last year, the average payroll penalty paid was $845. This type of expense is one that can be completely avoided by paying careful attention to detail or through hiring a professional payroll service.
Payroll penalties are a type of fine on payroll taxes. Most penalties imposed are due to the Trust Fund Recovery Penalty Tax, which requires a 100 percent penalty be paid to the IRS when payroll taxes withheld from employees' paychecks are not forwarded or improperly forwarded to the IRS. This penalty is imposed on parties found to be responsible for the improper forwarding.
All businesses with employees are required by federal law to hold back a portion of employees' pay for use in individual federal income taxes. Additional amounts are withheld for Social Security, unemployment insurance and Medicare. Companies are required to hand this money over to the IRS.
When this money is not handed over to the IRS, or if it is only partially handed over, it is considered to be unlawful retention. This unlawful retention is the basis for the payroll penalty. Besides the penalty, the company may also be liable for paying interest on the unlawfully retained amounts.
Depending on the number of employees and the amount of unlawfully retained tax funds, the penalty can be very steep at 100 percent. Because payroll tax withholdings are the federal government's number one source of revenue, the collection of these funds is the number one priority of the IRS, and they have extensive power in enforcing the collection of federal tax withholdings and, once assessed, the payroll penalty.
If the IRS can prove that an employer willfully failed to pay and/or file payroll withholding taxes, the responsible parties in the business can be legally prosecuted in federal court. Responsible parties may be the bookkeeper, accountant and/or the executives in charge. The IRS is not limited in assessing blame to a single individual in a company. They can assess the penalty and prosecute as many people as can be proven to be responsible.
Responsible parties are defined as persons whose duty it is to account for, collect, and remit the payroll taxes. Before prosecution can continue for payroll penalties, the IRS must also prove willfulness, which is committing an act consciously, voluntarily, or intentionally.