The IRS takes the withholding of funds from employee paychecks very seriously, and you should too.
Maybe you’re weighing the pros and cons of hiring your first employee. Maybe you’ve had employees for years and have been handling the payroll taxes yourself, but aren’t confident you’re doing everything exactly right. Or maybe you’ve outsourced the processing of payroll and hardly give it a thought. One thing is certain, where there are employees, there are payroll taxes, and where there are payroll taxes, there are opportunities for costly — even devastating — mistakes. Here are some of the most serious payroll mistakes:
Mistake No. 1: Setting up a payroll tax program and never thinking about it again. Business owners should continually evaluate and update their payroll programs to make sure payroll taxes are being properly withheld. State and local tax requirements can change over time, making it crucial to stay current.
Mistake No. 2: Ignoring payroll tax issues when they arise. When it comes to payroll taxes, the Internal Revenue Service doesn’t mess around. If notified by the IRS of a problem, you must take immediate action or you could find yourself out of business. If a business fails to file or pay its payroll taxes, the IRS has the authority to shut that business down without a court order. They can seize machinery and equipment. They can also intercept funds customers owe the business.
Mistake No. 3: Underestimating what a late payment will cost you. Payroll tax penalties add up quickly and can dramatically increase the total tax bill. You can be penalized for failure to file, failure to deposit and the failure to pay. If the 941 Payroll Tax Return is filed after the due date and taxes aren’t paid within 16 days of that filing date, penalties can be assessed, increasing the amount owed up to 33 percent plus interest. Falling behind and hoping to catch up usually doesn’t work. In addition, not filing or paying payroll taxes is considered a federal crime. The IRS can send your case to the Criminal Investigation Division and then to the Department of Justice if they can prove you intentionally didn’t file or pay. Procrastinating can cost you money, time, reputation and worse.
Mistake No. 4: Paying other bills first. If your business experiences a cash flow problem, you have to choose which bills to pay first. It’s tempting to pay vendors or utilities first, but that’s a mistake. Always make payroll taxes your highest priority. The dollars withheld from employees’ paychecks for income, Social Security and Medicare taxes are not yours. This money does not belong to the business. These are called trust fund taxes. It is employee money held back for a specific purpose. As a business owner, you are personally liable for paying these taxes even if your business is incorporated or is a limited liability company. Skip a payment or pay late and the IRS will charge a penalty equal to the unpaid taxes, plus interest. If you don’t pay the taxes, the IRS can seize your business’s equipment and your personal assets. You could even be charged with a crime because borrowing from payroll taxes is against the law. A federal tax deposit made by a tax filing service, by phone using electronic funds transfer or in person at a bank must be made three days after payroll checks are issued. Using the withheld money for any other purpose is stealing.
Mistake No. 5: Failing to keep accurate and complete payroll records. Because the IRS is such a stickler on payroll taxes, you’ll want to be an open book on how your company handles them. You are required to maintain payroll and have them available for IRS inspection. These records include copies of W-2s, employee time sheets and other payroll records. Keep all information for at least four years.
Mistake No. 6: Not knowing tax liability can vary by state or even county. Hiring people who live in a different state than the one your business is located in can create unemployment tax liability in their home state. States have different rules regarding payroll taxes and rates can even vary by county. Check with a CPA or tax attorney familiar with the rules and regulations for the states and counties in question.
Mistake No. 7: Improper timing of overtime and bonus checks. Even if your company doesn’t issue payroll checks weekly, overtime hours must be broken down in weekly increments or tax problems can arise. The same is true for bonuses. The payment of a bonus has to line up with the due date for payroll taxes. If the two payments don’t sync, there could be tax implications. A penalty could actually be the thanks you get from the IRS for wanting to reward an employee for a job well done. Don’t be a Scrooge, just consult Bob Cratchit — or whoever crunches your numbers — and make sure any bonuses and overtime pay are timed right.
Mistake No. 8: Not monitoring an outside payroll company. By now you’re thinking you should hand off payroll processing to an outside company, or you’re congratulating yourself for already outsourcing this critical task. Yes, using an outside payroll company to handle the job of calculating withholding and transferring funds to the U.S. Treasury to cover payroll taxes can be a good solution. Keep in mind however, that as an employer you are still ultimately responsible for payroll taxes. If you contract with a third-party payroll-processing company, make sure it is bonded for fidelity purposes. This means they have insurance to protect against losses, such as embezzlement by employees, not generally covered under normal theft policies. Also make sure tax funds your company advances to them are held in a separate trust fund. Protect yourself and your company by monitoring your tax account to see that funds are being deposited on time and in the correct amount.
A FINAL WORD
If you have employees, you must make the filing and paying of payroll taxes a priority. Don’t hesitate to consult a CPA if you have any questions or concerns. Being overly cautious is much easier than dealing with costly mistakes.