Tax laws require employers to withhold income, Social Security and Medicare taxes from employee pay and to remit those taxes to the federal government. Employers who fail to pay withheld taxes to the government face potentially significant penalties. In some cases, the IRS may seek to recover unpaid employee withholding taxes directly from business leaders and other “responsible persons” of the employer. Here’s a quick overview.
Employer obligations to withhold, report and pay
The Internal Revenue Code and Federal Insurance Contributions Act (FICA) impose numerous withholding-related obligations on most employers. In general, employers must withhold from their employees’ paychecks:
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Federal income taxes;
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The employee’s share of Social Security taxes, subject to certain income limits; and
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The employee’s share of Medicare taxes.
Employers must file quarterly tax returns to the IRS detailing the amount of withholding taxes they collect. Employers must also pay the collected withholding taxes to the federal government either monthly or semi-weekly.
Consequences of failing to pay employee withholding taxes
The IRS does not take kindly to employers who collect, but fail to pay-over to the government, employee withholding taxes. Failures to make timely deposits or to report withholdings can subject employers to civil penalties and interest. It can also expose certain individuals to personal liability for what is known as the Trust Fund Recovery Penalty (TFRP).
By law, employers who withhold taxes from employee paychecks hold those funds in “trust” until remitting them to the United States Treasury. A trust, in a nutshell, is a legal obligation to safeguard property for the benefit of someone else (here, the federal government and the employees whose taxes were withheld).
To make sure employers fulfill their trust obligations, Congress passed a law that makes certain “responsible persons” of an employer personally liable for any employee withholding taxes the employer has failed to pay, plus interest (the combined amount of which constitutes the TFRP). A responsible person is a person or group of people who has the duty to perform and the power to direct the collecting, accounting and paying of employee withholding taxes, such as a corporate officer or director, a small business owner, or a third-party payroll company.
The IRS can pursue responsible persons for payment of the TFRP if they “willfully” fail to remit employee withholding taxes. Willfulness exists when a responsible person:
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Was, or should have been, aware of the outstanding taxes; and
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Either intentionally disregarded the law requiring payment, or was plainly indifferent to its requirements, even if the person did not have wrongful intent.
An experienced tax lawyer can advise employers of their obligations and options when faced with potential penalties, including TFRP liability, for having failed to pay employee withholding taxes.