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  3. Employment Tax Law
    4.  — FAQ On Employment Taxes

Questions About Taxes And Your Business?

The United States Tax Code requires employers file and pay employment taxes. This generally includes withholding and paying the federal income tax, a portion of social security and Medicare taxes from the employee’s wages as well as the employer’s matching contribution, and federal unemployment tax.

Unfortunately, the reality of these obligations is more than just going through a checklist. A mistake can lead to serious penalties and if the Internal Revenue Service (IRS) believes a mistake was more than a simple error — if they can establish that the mistake was an intentional attempt to avoid tax obligations this error could even lead to allegations of criminal wrongdoing.

Because of the threat of these serious consequences business owners are wise to take their tax obligations seriously. The tax law is complex, and you likely have a lot of questions about how to navigate these obligations. We discuss some of the more common below.

#1: How do I choose a third-party payroll provider?

It is important to choose a third-party payroll provider with care. In some situations, the payroll provider is responsible for tax reporting but in many the IRS will still hold you liable if a mistake is made.

How do you make sure you choose one that will not make a mistake, or at least one that has some skin in the game? First, become familiar with the different types of providers. The IRS recognizes four:

  • Payroll service provider.
  • Reporting agent.
  • IRC Section 3504 Agent.
  • Certified professional employer organization (CPEO).

Next, know what types of responsibilities come with each provider category. Of these four options, only the last two have employment tax liability. If you chose to work with a payroll service provider or reporting agent, you will generally remain legally liable if there is a mistake in tax reporting and payment.

The IRC Section 3504 Agent shares liability for paying and filing tax returns. This means if there is an issue, the IRS could come after both you and the agent. In contrast, a relationship with a CPEO generally results in the CPEO having sole liability for these responsibilities. As such, employers can mitigate the risk of employment tax liability issues by choosing a CPEO. If you choose this route, it is a good idea to review the list provided by the IRS of all CPEO organizations. However, the IRS notes that the names of CPEOs can be similar to other third-party payroll vendors. As such, it is a good idea to verify the Employer Identification Number (EIN) of the CPEO before entering into a contract for these services.

Regardless of which option is chosen, the IRS encourages the use of Electronic Federal Tax Payment System. The agency states the system provides safe and easy online access and records of payment history, allowing you to better monitor your tax responsibilities and payment history regardless of which payroll provider you choose to use for your employment tax services.

#2: What should I do if the IRS claims my business misclassified employees?

First, it is important to recognize that this is a big deal. The IRS has cracked down on the misclassification of workers as independent contractors instead of employees in recent years. The IRS looks at these cases as business owners attempting to get out of their tax obligations, as an avoidance of paying employment taxes, and will fight for repayment. Allegations of a violation can result in a huge tax bill to make up for the lack of employment taxes as well as additional penalties and assessments against responsible persons.

If the IRS investigates worker classification, it will look at three categories: behavioral control, financial control, and the relationship between the employer and the worker. When reviewing the behavior, the IRS looks at who determines when and how the work is complete. For the financial aspect, they look to how the worker is paid and who provides the materials or tools needed to complete the job. The IRS will also look into the provision of benefits like insurance or retirement and whether or not the arrangement is set to continue after a specific task is complete to determine the relationship.

The IRS will expect the repayment of employment taxes if it finds that the business misclassified an employee as an independent contractor. These penalties can increase if it finds that the employer intentionally disregarded the reporting requirements.

Business owners who believe they may have misclassified a worker in error have options. One is the Voluntary Classification Settlement Program (VCSP). This program allows business owners the opportunity to reclassify workers for future tax periods for employment tax purposes. In exchange for voluntary involvement, the business owner will receive partial relief from the penalties noted above. Eligibility requirements include:

  • History of tax filings. Business owner filed all required Forms 1099 for reclassified workers for the previous three years.
  • Voluntary participation. The taxpayer must choose to participate voluntarily. They cannot attempt to partake in this program while they are the subject of a federal or state audit.
  • Complied with previous audit. The fact that a business was the subject of a previous audit does not necessarily remove them from eligibility, but the IRS does require that the business complied with the results of the previous audit.

It is important to point out that the above is the federal test to determine the proper classification of a worker — each state may have different, potentially stricter rules. It is important to review your case closely and consider whether this program or another option is the best response in your situation.

#3: Is a business owner ever personally liable for a business’ tax mistakes?

The answer to this question often hinges on the business structure as each is taxed differently. The IRS generally views the business and the owner as one in the same when the arrangement is a sole proprietorship. As a result, the business owner is liable for the business’ tax mistakes in this situation. The IRS generally treats partnerships and limited liability companies (LLCs) this same way.

The answer becomes a little more nuanced when the business is set up as a corporation. This is because the IRS generally views a corporation as its own entity subject to taxes and liability separate from the business owners or partners. However, there are situations when the IRS can “pierce the veil” or the protective wall that separates the business from the owners. This includes when the business fails to withhold employment taxes. If this happens, the IRS could hold the individual business owners personally liable.