There are some types of law-breaking that the IRS views as worse than others. One of the most egregious errors targeted by the agency is unpaid payroll taxes that businesses collect from their employees. Business owners who fail to remit these funds to the IRS on time and in full are vulnerable to harsh penalties, and possibly even jail time.
Payroll taxes make up a huge portion of the tax pool. Thirty-one percent of taxes collected by the federal government in 2021—or $1.25 trillion out of $4.1 trillion total taxes—were payroll taxes. As businesses collect these taxes throughout the year, they are instructed to place the money in a trust fund until it’s ready to go to the IRS on a quarterly, monthly, or even biweekly basis.
In the Covid-19 era, a cash-strapped small business owner may have felt tempted to borrow from the fund before it’s sent to the IRS. After all, the money is sitting right there, and unless they’ve hired someone to manage the fund, they probably had direct access to the money.
These business owners aren’t being malicious most of the time; they’re simply trying to keep their lights on or bolster their marketing budget to acquire new customers. They intend on refilling the account before it’s time to pay.
But sometimes that’s easier said than done. Perhaps they forget to pay the money back, or the future gains they expected never materialize. Before they know it, they’ve fallen several years behind and they’re drowning in thousands of dollars of tax debt—or worse.
Why ‘Borrowing’ Is a Terrible Idea
I can’t stress this point enough: Never “borrow” from your payroll tax fund. Other than tax evasion, payroll taxes are the worst type of tax debt you can have. The IRS views this as stealing from two groups—the employee and the government—even if you fully intend to pay them back. Failure to properly collect and send payroll taxes to the IRS can result in a maximum penalty of five years in prison, plus a fine of $250,000, or twice the gross gain or loss from the offense—whichever is greater.
It’s tough running a small business, and Covid-19 has only made it harder. After losing customers and struggling to survive, it’s understandable that some would be looking anywhere and everywhere for a little extra cash.
But not only is paying your taxes on time the right thing to do; the IRS also can be aggressive in getting this type of money back. In 2021, an Illinois man who ran two staffing companies was sentenced to 48 months in prison for failing to pay $4 million in payroll taxes. The owner of a New York-based diner faces one year and a day in prison, followed by three years of supervised release, for dodging payroll taxes from 2007 to 2017.
Most people caught for failing to remit payroll taxes don’t go to prison; they usually have an opportunity to make things right with the IRS. But the risk of legal trouble, plus the high cost of restitution—including penalties and interest—make this a particularly dangerous zone for business owners.
Expect the IRS to Start Collecting With a Vengeance
The payroll tax issue isn’t going away, but do you know what is? Any concessions the IRS made during Covid-19. Demand notices diminished during the pandemic. The IRS even waived or refunded $1.2 billion in failure to file penalties. But taxpayers shouldn’t start thinking that this is the new normal.
With the Inflation Reduction Act, Congress decided to raise money to pay for new programs by going after the taxes already owed to them rather than raising new taxes. The government estimates that from 2014 to 2016, the gross tax gap was $496 billion, up by $58 billion from the previous period, so closing the gap could bring in big money.
To help close this gap, the government is investing in the IRS. The new law sets aside $80 billion in IRS funding over 10 years, $45.6 billion of which dedicated to enforcement activities that can be used to hire agents, provide legal support, and create “investigative technology.”
The new enforcement agents will be eager to make a name for themselves by pursuing more audits and bringing in more money. Meanwhile, the recession will make paying tax debt even more challenging for small businesses. The scarcer money is, the harder it is to cover necessary expenses.
Three Measures Businesses Can Take
Once you’re aware of the trap, how do you avoid it? While there’s no miracle solution, anyone who takes the following steps will lower their chances of making this mistake.
Get a bookkeeper. Take a good, honest look at yourself and ask whether you’re wired to deal with employee payroll taxes. If you think you might be tempted to dip in, maybe it would be best if you never see the money. Hire someone else to manage the fund. Putting a tax professional between you and the account will make it much harder to misuse the money.
Count on recessions as part of the business cycle. Business owners are more likely to use payroll tax money when their finances are in trouble. I’d recommend doing business as if you’re always in a recession, so you’re saving as much as you can in good times and bad. If you always operate like that, it’ll feel like a windfall when the economy is on an upswing.
Reach out to a business that specializes in tax resolution and problem-solving all day, every day. You may need more than an accountant. In some cases, you should partner with a professional organization that specializes in tax issues—especially if you’re already in tax trouble. I can say confidently that we’ve seen it all. Have the humility and knowledge to know what you’re good at and focus on that, and leave the taxes to the experts.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Scott Curley is the co-CEO of FinishLine Tax Solutions, a national tax resolution firm specializing in tax relief and tax preparation services. He has helped individuals and businesses take control of their tax problems, settle taxpayer debt, and work to prevent the IRS from garnishing wages and seizing assets.
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