When most people think of the word “tax,” the first thing that usually comes to mind is the income tax levied by the IRS. This is natural as most everyone has to pay income taxes and we are reminded of that fact every April 15.
However, for business owners, employments taxes are just as important, if not more so.
Generally, businesses have to pay Social Security and Medicare taxes (FICA), unemployment taxes (FUTA) and withhold from their employees’ paychecks their employees’ share of FICA and income tax withholdings and pay that over to the IRS for their workers.
The Internal Revenue Code makes employees liable for half of the FICA and employers must pay for the other half. The employee does not have to file employment tax returns. Instead, the IRS puts that burden on the employer and the IRS treats the employer as a “trustee” of those FICA and income tax withholdings to be turned over to the IRS on behalf of the employee. California has its own employment tax that is collected by the EDD and essentially the same rules apply.
On a business’s employment tax return, Form 941, these taxes are broken down into three elements: (1) the amount of FICA owed by the employee; (2) the amount of FICA owed by the employer; and (3) the amount of income tax withholding the employer pays to the IRS on behalf of the employee. Each of these are distinctive amounts that must be determined.
Employers can run into major problems when they do not file employment tax returns or fail to pay the amount due. As stated earlier, employees do not have a duty to file employment tax returns and the IRS will credit their account whether their employment tax was paid or not by the employer. Therefore, in order to make sure the IRS is collecting the employment tax due, it will conduct audits or initiate collection proceedings against employers that run afoul of the law.
When the IRS audits an employer, there are several potential violations they are looking for. However, one of the biggest violations an employer can run into is when they misclassify employees as independent contractors. When a business pays an independent contractor, they do not owe any FICA on the independent contractor and they are not required to withhold any income tax from the independent contractor. The business simply pays the contractor and files a Form 1099 to report the gross income paid to the contractor.
Treating employees as independent contractors can save a business a lot money as they don’t have to pay employment taxes on those payments. However, if the IRS believes those independent contractors are really employees, they will audit the employer and apply the “20 factor” employment test against each type of worker. If the IRS determines the workers are employees, it will typically assess new employment taxes against the business for three years’ worth of employment taxes (12 quarters). This type of assessment can be a business killer.
Similarly, if the employer failed to pay the taxes due on their filed employment tax return, the IRS will institute collection activities against the business.
To assure payment of the employment taxes by corporate taxpayers, the IRS assesses what is known as the trust fund recovery penalty (TFRP) against the responsible persons of the corporation to make sure someone is liable for payment of the FICA and income tax withheld from the employees’ paychecks.
As stated earlier, the IRS treats the employer as the trustee for FICA/income tax withholdings and if the business does not pay those amounts over, then the employer becomes liable for the whole amount. The IRS has the authority to not only collect from the business itself, but management and owners of the business personally, and potentially even employees of the business.
We have even seen the IRS even try to go after lawyers and accountants if they had any part in handling the employer’s bank accounts and payroll. The main reason that employers need to take employment taxes seriously is because, unlike income taxes, the bulk of employment taxes cannot be discharged in bankruptcy.
Employment tax should be treated as a priority debt. The IRS has greatly increased their enforcement of employment tax law and businesses of any size can be a target. If you have been treating employees as independent contractors and are concerned about an employment tax audit or have employment tax debt, you should talk to your tax professional as soon as possible to be informed of your options to try and rectify your problem before it is too late.
– Jason W. Harrel is a Partner at Calone & Harrel Law Group, LLP who concentrates his practice in all manners of Taxation, Real Estate Transactions, Corporate, Partnership and Limited Liability Company law matters. He is a certified specialist in Taxation. Mr. Harrel may be reached at (209) 952-4545 or [email protected]
– Darren J. Pluth is an Associate at Calone & Harrel Law Group, LLP who concentrates his practice in all manners of Taxation. Mr. Pluth may be reached at (209) 952-4545 or [email protected]