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The Risks and Penalties of Payroll Tax Avoidance

Posted by Peter DeMarco on Sep 20, 2013 12:37:00 PM

If you're an employer, you already know how deep an obligation you have to your employees. You may also know how surprisingly complex, and unending, payroll tax compliance can be. Just accounting for payroll taxes within the countless other additional taxes, fees and expenses involved when you own or manage a business can make eking out a sliver of profit seem a formidable challenge. 

Because payroll taxes are both significant and ongoing as an expense, it's understandable that you might be tempted to find some way to minimize your payroll tax obligation.  Many managers or owners have just one casual discussion with the wrong advisor, and subsequently, are a fine line away from dealing with a tough minded enforcement arm of the IRS or other state agency.

So What are the Risks and Penalties of Payroll Tax Avoidance?

The main risk in attempting to avoid payroll taxes comes from understanding why Americans pay payroll taxes in the first place, and how that happens.  In the broadest sense, payroll taxes are contributions to enormous insurance funds - of which Social Security and Medicare are the two most identifiable pools.  Just as important are contributions to state level unemployment insurance and disability funds.

Both employee and employer share responsibility in contributing a share into these funds.  Moreover, a traditionally-retained employee, who is paid an hourly wage or by salary, generally has no choice on whether or not to contribute - amounts are automatically deducted from gross pay.  An employer should be holding those funds only in escrow, committed to remitting them within a short window after the pay period. Even independent contractors are required, through quarterly estimated tax, payments, to remit their share.

Anyone working within any part of the American economy is supposed to be chipping in, and tax is collected on a "pay as you go" interval: this interpretation has decades-long support throughout the tax, civil and criminal judiciary. Internal Revenue Service settlements and jury decisions have made it, very simply, a fact of 20th and early 21st century business life.

The biggest risk of avoidance, then, is that most forms of payroll tax avoidance can be equally interpreted as payroll tax evasion. So, what are the penalties for payroll tax evasion?  For starters, underpaying or paying a single pay period late triggers an IRS penalty for "Failure to Deposit," which climbs to 15% as soon as 30 days after a specific pay period.  State tax authorities have their own penalties which generally mirror this.

If you become an employer who is found to knowingly misuse or are found to intentionally misstate your payroll responsibility over a period of time, you may become subject to a dreaded "100% penalty," which means exactly what it's named.  Also known as the Trust Fund Recovery Penalty, this provision of the tax code is only waived or abated when your business has been certifiably a victim of casualty, such as a natural disaster.  This penalty can represent a serious threat to everything you've built.


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In the end, avoiding payroll taxes, out of bedrock principle, is rarely looked at in a favorable light. Remember that you live at a time when more and more financial information is digital, downloaded and electronically reconciled.  In addition, the IRS has identified small businesses as one of its more stubborn compliance classes.

More productively, there are ways to minimize payroll tax expense without resorting to avoidance/evasion strategies.  You can engage a professional, either an accounting firm or a dedicated payroll specialist, to oversee compliance and regularize procedure.  This goes a long way, by itself, to avoid late-paying or late-filing expense.

Topics: Tax Planning & Strategies

Peter DeMarco

Peter DeMarco

Peter DeMarco, with nearly three decades of tax planning experience, is a Vice President at Meaden & Moore as well as Director of the Tax Services Group.

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