Behind on payroll taxes: what the IRS can do and what to do now

Part of it was never the business's money. The income tax and the employee share of Social Security and Medicare tax you withhold are "held in trust until they are paid to the Treasury," per the IRS page on trust fund taxes. That is why they are called trust fund taxes.

Employers report these taxes on Form 941 each quarter, due by the last day of the month after the quarter ends, and report federal unemployment (FUTA) tax on Form 940 once a year, according to the IRS employment tax due dates page. Deposits are made electronically during the year. When deposits stop, the IRS can charge a failure to deposit penalty of up to 15% of the amount not deposited on time, per Publication 594.

It is a penalty that makes a person, not just the business, owe the unpaid trust fund taxes. The IRS manual says the penalty "is based on IRC 6672." The amount equals the unpaid trust fund tax: the income tax withheld plus the employee's portion of the withheld FICA taxes, per the IRS Trust Fund Recovery Penalty page.

It can be assessed against any person who was responsible for collecting or paying the taxes and who willfully failed to do so. That can include officers, partners, directors, shareholders and anyone with authority to direct how money is spent. Willful does not require bad intent. The IRS says "using available funds to pay other creditors when the business is unable to pay the employment taxes is an indication of willfulness." The business does not have to close first, and once the penalty is asserted the IRS can file a lien or levy against your personal assets.

They are the two steps that usually come before the penalty. Form 4180, Report of Interview with Individual Relative to Trust Fund Recovery Penalty, is the form an IRS revenue officer uses to interview people who may be responsible. The IRS manual says it is completed in person or over the phone, and is not mailed out in advance. The answers are used to decide whether you were responsible and willful.

If the IRS decides you are responsible, you receive Letter 1153 and Form 2751, Proposed Assessment of Trust Fund Recovery Penalty. Publication 594 gives you 10 days from the date of the letter to tell the IRS you disagree or have more information, and 60 days from the date of Letter 1153 to appeal. If you do not respond, the IRS assesses the penalty against you personally and begins collecting it.

The business itself faces normal collection, sometimes faster. The IRS can file a lien and levy business assets. A business balance often shows up as a CP504B notice of intent to levy. That notice says that after 30 days the IRS may serve a Disqualified Employment Tax Levy. Publication 594 explains that this levy can be served when a taxpayer previously requested a Collection Due Process appeal on employment taxes for other periods within the past 2 years. For how levies work, see IRS levy help.

1. Make this payroll's deposit. New unpaid quarters make everything harder. The IRS also requires employers to be current on deposits for the current and last two quarters before it will consider an offer in compromise.
2. File every missing Form 941 and 940, even if you cannot pay. Publication 594 says to file all returns that are due, regardless of whether you can pay in full.
3. Stop paying other bills with withheld tax. That is the pattern the IRS treats as a sign of willfulness.
4. Pull your records: payroll reports, bank statements, and who signed checks and decided which bills got paid.
5. Do not sit for a Form 4180 interview unprepared. Get advice first.
6. Read every IRS letter for its date, especially a Letter 1153.

Blaga Veleva, EA can represent the business and you personally under Form 2848. Publication 594 lists enrolled agents among the people who can represent you during collection and appeals. She can get the account transcripts for each quarter, check which penalties apply, and prepare the missing returns.

Then she works on resolution. Business taxpayers set up payment plans by calling the number on the notice or 800-829-4933, per the IRS payment plans page. Failure to deposit penalties can qualify for First Time Abate, and the IRS lists Forms 940 and 941 among the returns eligible for the new Automatic Exemption from Penalty. See penalty relief.

Before starting this firm, Blaga worked as a Controller at an industrial energy company, so she knows how payroll, cash flow and the books connect. Tax & Business Solutions does not run payroll. It handles the tax, the IRS and the catch-up bookkeeping behind it.