Published on February 15th, 2016 | by Millennium Magazine Staff0
Depositing Your Employees’ Withholdings
By BarbaraWeltman, Guest Blogger
As an employer, when you withhold income taxes or other funds from employees’ paychecks, you’re obligated to apply the funds appropriately in a timely manner. If you fail to do so, you can be severely penalized. Understand your deposit responsibilities, the consequences of failing to adhere to them, and what you can do to ensure you’re doing the right thing.
Certain taxes are imposed on an employer: the employer’s share of Social Security and Medicare (FICA) taxes, federal unemployment (FUTA) tax, and state unemployment tax. However, employers are also required to collect from employees federal (and where applicable state) income tax, called income tax withholding, as well as the employees’ share of FICA tax. Employees’ taxes are called trust fund taxes because the withholdings are held in trust for employees; the funds don’t belong to the employer. Employers must remit the employees’ withholdings in a timely manner.
Timely deposits. If employment taxes for the quarter are $2,500 or more, you must timely deposit federal employment taxes with the Treasury. If such taxes are under $2,500 for the quarter, instead of depositing them, you can simply send a check when you file your quarterly employer return (Form 941). And if these taxes are $1,000 or less for the year, you can pay annually (Form 944) (the IRS notifies you that you’re eligible for annual filing, and paying employment taxes at that time).
The definition of “timely” for depositing employment taxes depends on the amount of these taxes. Generally, there are two deposit schedules: monthly and semi-weekly. At the start of each year, determine which schedule to use based on the amount of employment taxes during a “lookback period,” which is usually the prior 12 months. The monthly deposit schedule applies if you reported taxes of $50,000 or less (many small businesses); the semi-weekly deposit schedule applies if taxes are $50,000 or more. (A next day deposit rule applies to very large employers.)
Penalty for failure to make timely deposits. In general, if you fail to make timely deposits, there’s a 15% failure-to-deposit penalty. However, if you “willfully” fail to deposit the trust fund taxes, a 100% penalty is imposed on the “responsible person.” If you withhold funds from an employee’s paycheck but don’t deposit the money with the Treasury, you’re personally liable for all of the undeposited amount. This penalty, called the trust fund recovery penalty (TFRP), applies even though your business is organized as a corporation or limited liability company designed to provide you with personal liability protection.
A “responsible person” is someone who has the duty and power to collect and pay trust fund taxes. Usually this is an owner who can sign checks, but many others can be treated as responsible persons.
A “willful” failure to deposit the taxes results when the responsible person knows or should have known that the taxes weren’t deposited and effectively disregards the law. For example, if cash flow is tight and the owner of a company knows that funds that should be deposited are instead used to pay a supplier or the rent, this is viewed as a willful failure. No evil intent or bad motive is necessary for the penalty to apply.
Strategy. To avoid the 100% personal liability for unpaid trust fund taxes, it’s a good idea to establish company procedures which ensure that trust fund taxes are deposited before any other creditors are paid.
Find more information about the trust fund recovery penalty (TFRP) from the IRS.
If your company has a 401(k) plan or SIMPLE-IRA, employee contributions through salary reductions (“elective deferrals”) must be timely deposited with the financial institution where you maintain the plan.
Timely deposits. Generally, elective deferrals must be deposited on the “earliest date on which such contributions can reasonably be segregated from the employer’s general assets.” They cannot be made later than the 15th business day of the month following the contribution is withheld. However, small businesses (those with fewer than 100 participants in the retirement plan) enjoy a safe harbor: deposits are timely if made no later than the 7th business day after the date the deferrals would otherwise have been paid in cash to participants (i.e., payday).
Penalties for the failure to make timely deposits. This mistake is viewed as a prohibited transaction triggering a 15% excise tax. If the mistake isn’t corrected, the penalty can be substantially greater. Find more about fixing a late deposit from the IRS.
Missteps in depositing employees’ funds in your care can cost you dearly. Be sure to understand your deposit obligations. Work with a knowledgeable CPA or other financial advisor to make sure you meet deposit responsibilities and avoid penalties.