Volume 8 Issue 6 -- November/December 2004
Volume 8 Issue 6 -- November/December 2004
You have heard of Fahrenheit 911, but here is another situation involving numbers, more specifically, a gamble that you should not take. You have heard of some who “bet the farm” on a certain venture. Far too many business executives in trouble take a similar “bet the farm” risk with payroll taxes. When things get tight, they elect to borrow, in effect, from the “Bank of the IRS.”
As all responsible employers know, they are supposed to withhold amounts from their employees for the employees’ federal and state taxes and for the employees’ portion of social security. If an employer gets behind with creditors, it is tempting for some to pay withheld amounts late. Stated differently, they take a loan from the Bank of the IRS. This type of loan is fraught with risks and penalties.
When an employer collects withholding taxes from employees, the payroll of the employee is reduced accordingly. To the extent of state, federal and city withholding, plus social security, an employee’s gross pay is reduced. If a pay stub is issued, the employee can see the amounts withheld.
These withheld amounts (plus the employer’s portion of social security) are reported to the IRS on Form 941. This form is a quarterly tax return for these types of taxes. Since the funds withheld can be used for other sources, if not paid to the government, it is tempting to do just that. For example, if you run a restaurant and you do not pay for the bread, you do not get bread. You need bread everyday.
Unfortunately, the IRS is not in “the face” of all taxpayers everyday and so the IRS can and does let unpaid withholding taxes mount up for quarters, and even years, at a time.
If a distressed business fails, there may be no assets left to collect tax
from. Years ago Congress addressed
this issue and passed a special section of the IRC that imposes a penalty on
“responsible parties” who had something to do with the failure of the
business to remit the withholding taxes to the IRS.
The penalty, which used to be called the “100 Percent Penalty,” is
now called the “Trust Fund Penalty.” The
purpose of the Trust Fund Penalty is to impose on the “responsible parties”
the amount that was collected from employees and not remitted to the
The Trust Fund Penalty is the amount of the employees’ withholding and social security payments. For rough computational purposes, it usually averages about 75% of the total tax liability reflected on the 941 Form.
Another way of considering the penalty is that it is the total on the Form 941 less the amount the business owes from its own funds (the employer’s 1/2 of social security). The responsible party test is enforced by the IRS vigorously, and business officials with very little proximity to the situation are often charged with the penalty.
Often, when a business fails, the principals may also declare bankruptcy. Unfortunately for such former business officials, the Trust Fund Penalty is not forgiven or forgivable in bankruptcy. Some people think that if their company goes under, they can declare bankruptcy and be rid of the debt. Not so with the Trust Fund Penalty.
While it is possible to get some executives absolved from the Trust Fund Penalty, it is often very easy to be affiliated with the employer in such a way that you are a responsible person, particularly if you signed payroll checks.
You may want to read our sister company’s newsletters related to Trust Fund Penalty disclosure, which are available on our Web site. Rather than focus on the intricacies of the Trust Fund Penalty, it might be a better guidance to suggest that the chance not be taken.
The IRS has a habit of showing up last in the collection process – but with the most power. Stated differently, the laws favoring the government in the collection of taxes are substantial. In nearly all cases involving the 941 roulette, the principals lose. Of all the forms of betting, the most deadly is that of 941 roulette. Don’t play it.
If you have played it and lost, you may want to read some of the newsletters referred to above, or call Newland & Associates for help.
Published by the law firm of Newland & Associates, PLC
9835 Business Way
Manassas, VA 20110
Call us at (703) 330-0000 for a full range of business law and tax-related services.
While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.
Redistribution or other commercial use of the material contained in Newland's Business Notes is expressly prohibited without the written permission of Newland & Associates, PLC.
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