IRS Employment Taxes - FICA and Payroll Withholding Issues
Employment tax issues involve: FICA taxes (also called social security and Medicare taxes) and FWT / Payroll withholding. There are quarterly payroll tax returns (IRS Form 941) that the employer is supposed to file with the IRS.
For businesses with IRS tax issues, it will more likely than not involve FICA or Federal Payroll Withholding tax trust fund issues. This is a really interesting for your IRS tax lawyer because there are many ways to solve IRS employment tax issues and your tax professional gets the satisfaction of being able to help business owners stay in business and get back on track with the IRS.
However, when dealing with employment tax trust fund issues, the IRS is usually more difficult to deal with and getting the advice of an experienced IRS attorney is of paramount importance
What are FICA and Federal Payroll Withholding Taxes?
FICA stands for Federal Insurance Contributions Act and refers to the social security (OASDI) and Medicare taxes paid by both individual employees and their employers. For FICA taxes, the employer is supposed to withhold 50% of the tax from the employee’s paycheck to pay to the IRS (on behalf of the employee) and the employer itself pays the IRS the other 50%. The total FICA tax is 15.3% of the employee’s gross pay. The employee and employer each pay 7.65%
The income of self-employed business owners are not withheld under FICA but they have to contribute under SECA (Self-Employed Contributions Act).
How are Payroll and FICA taxes withheld?
For Federal Payroll Withholding taxes, 100% is withheld from the employee and employer sends the withheld amount directly to the IRS to pay toward the individual employee’s income taxes owed. For this reason, payroll withholding taxes are also referred to as “pay-as-you-earn” taxes. The more money that is withheld the higher chance the taxpayer will be entitled to a refund. The employee can change their payroll withholding amount by filing a new Form W-4.
For FICA and payroll withholding - the employee’s share is referred to as “trust fund money” because the employer is supposed to hold it in trust for the benefit of the government.
How does the IRS assess penalties on FICA and payroll withholding taxes?
For penalty assessment purposes, the IRS focuses on what is called the “deemed” due date. All four quarters have a deemed due date of April 15th on the year following the year to which they apply OR the actual filing date, whichever is later.
For example 2018 employment taxes have a deemed due date of April 15, 2019, if they were timely filed. If returns filed after April 15, 2019, then the date of the actual filing would be marker by which the IRS would calculate its assessment.
Trust Fund Recovery Penalty Assessment Statute of Limitations
However, the IRS must assess the actual trust fund recovery penalty within three years of the deemed due date. So if the corporate tax returns are all filed on time but the FICA or payroll withholding taxes just had not been paid by April 15, 2017, the IRS must assess the responsible individual taxpayer by April 14, 2020.
Remember, the company still owes the trust fund taxes - that statute of limitations is 10 years. So if the corporate entity is viable collections actions can still be initiated within that time frame….. Just not against individual taxpayers as a trust fund recovery penalty.
What is the IRS Trust Fund Recovery Penalty?
This is a penalty assessed against an individual held to be responsible for the entity that should have been paying the Withholding or FICA taxes. The IRS can deem any of the following as “responsible” for the business entity’s failure to pay withholding taxes: shareholders, officers, the single owner of a disregarded entity. Lesser known responsible parties include: bookkeepers (even though they have no ownership interest in the company, if they have the power to pay and willfully do not do so), and bankers, whose clients have not paid withheld payroll trust funds owed (if the banker only loans enough to cover net payroll as opposed to gross payroll, which would allow the employer to pay the IRS what is owed from withholding).
But generally, the trust fund recovery penalty is there so the IRS can go after business owners individually if the business itself shuts down or becomes insolvent.
Which Taxpayer is Responsible and Willful
The person assessed with the IRS trust fund recovery penalty must be deemed both “responsible” and “willful” for each quarter in order for the penalty to be assessed against him or her. The IRS makes this determination by using a Form 4180 Responsible Person Interview. Using a series of yes/no questions the interview will determine if someone is responsible and willful (or whether more than one person is responsible and willful, in which case they will be held jointly and severally liable).
A responsible party must have the power to:
- pay the tax;
- determine which bills are paid (i.e. pay this supplier vs. pay the IRS); and
- make decisions on what bills are paid.
A willful party must have:
- Known that the tax was due/outstanding;
- Control over corporate funds; and
- Have prioritized one creditor over another (e.g. a supplier vs. the IRS)
If an individual taxpayer is told by the IRS that they have been deemed a responsible and willful person for a trust fund recovery penalty assessment, the taxpayer has 60 days to file a protest (from the date the letter is sent to the taxpayer).
Remember, the IRS is looking to include as many people as possible to be held responsible for trust fund recovery penalties. So they’ll cast a wide net, which is why it is helpful to retain an experienced tax defense lawyer to assist if the IRS ever claims that you are both responsible and willful for IRS trust fund penalty purposes.
A spouse who has nothing to do with the business will not be liable to the IRS
Frequently the taxpayer who is responsible (individually) for his/her business’s trust fund recovery penalty will be married and perhaps file his/her income tax returns jointly with the spouse. However, the spouse who is not a co-owner or who has no operational connection with the business will not be individually liable for the tax penalty.
What happens if the company that owes the payroll withholding tax shuts down and reopens another entity?
People try to get clever. But the IRS has a way to suss out this type of scheme and the ability to nominate another company as owing the same payroll taxes be designating the second company as an “alter ego” of the first - especially if the newly-created corporation has the same owners engaged in the same business, in the same industry, at the same location, using the same equipment, etc...
How your IRS lawyer defends the Trust Fund Recovery Penalty Case?
To begin, your IRS defense lawyer will conduct its own 4180 interview to figure out how it can explain to the IRS that our client is not responsible and/or willful. We will look at - who is on the bank signature cards? Who has the real bill paying authority (not just who does it for convenience)? Whose signature appears on copies of cancelled checks (signature different on regular checks vs. payroll checks)? (is that person really responsible for determining who gets paid or is that person just performing a clerical function at the direction of another?)
The taxpayer, even when hiring an IRS tax defense attorney, will need to meet with an IRS revenue officer for a 4180 interview. You want to go in with your tax lawyer as opposed to going at it alone. We will then mail in our own 4180 form (with complete answers…..”yes, but….” with explanations illustrating why the taxpayer was not responsible or willful for IRS trust fund recovery penalty purposes).
If the taxpayer is obviously the one responsible and willful, it wont make sense to conduct a trust fund recovery penalty defense. Instead, we will advise to taxpayer to let the IRS assess the trust fund recovery penalty and discuss another IRS legal defense tool, such as an offer in compromise, penalty abatement or installment agreement.
Also, on a practical note, if you are a business entity that has not paid payroll taxes, and are in a position to do so, try to stay current. You’ll never be a satisfied IRS defense client if you continue to accrue penalties while your tax defense lawyer is working on a prior year’s employment FICA / payroll withholding tax case.
In addition, if the trust fund assessment and penalty can be paid at the corporate level, the entity can use it as a tax deduction. If the company can’t (or doesn’t) pay the trust fund recovery tax penalty, and the IRS has to assess it against the responsible individual(s), the payment to the IRS is NOT tax deductible. So, your IRS debt lawyer will advise the company to pay the trust fund assessment whenever possible.
If the business doesn’t have the ability to pay, it may make sense for the individual taxpayer to loan the money to the entity for this purpose (with a valid/properly executed promissory note), just so the corporation can pay the tax.
If the business is no longer viable, it may make sense to sell assets (equipment, accounts receivable, etc..) so the company can submit proceeds to the IRS to have applied against the payroll tax so that there won't be any individual assessment. Then the IRS will not be able to conduct any more collections efforts on a defunct entity (if there are other types of IRS debt issues).