Payroll tax penalties and how to avoid them

Payroll tax penalties are an avoidable business expense, yet, each year, many organizations fall prey to them. This is largely due to incorrect calculations, missed deadlines and improper reporting. Employers can minimize these expensive mistakes with a meticulous payroll process, but as their business grows in size and requirements become more complex, working with a payroll provider may be a better way to support compliance.

What are unpaid payroll tax penalties?

Payroll tax penalties, more properly known as employment tax penalties, are fines levied by government agencies on employers who don’t fulfill their tax responsibilities. The most common is the Trust Fund Recovery Penalty (TFRP), which occurs when employers willfully fail to collect the requisite taxes from employee wages or pay them.

What payroll taxes are you required to pay?

Employers are required to withhold and pay all employment taxes that apply to their business. This may include income taxes, Federal Insurance Contribution Act (FICA) taxes and unemployment taxes, among others.

FICA taxes and Form 941

Employers must withhold FICA taxes, also known as Social Security and Medicare taxes, from employee wages and pay an employer portion (up to the Social Security wage base). Payment schedules vary with payroll size, but FICA taxes are commonly paid monthly or semi-weekly and are reported quarterly via IRS Form 941, Employer's Quarterly Federal Tax Return.

Federal and state income taxes

The IRS, most state governments and some municipalities require employers to withhold income tax from their employees’ wages. Like FICA taxes, federal income taxes are due monthly or semi-weekly and are reported quarterly on Form 941. Due dates for state and local income taxes vary by location.

Federal unemployment taxes and Form 940

Businesses that pay $1,500 or more to employees in any one quarter or have one or more employees for 20 or more weeks in a year generally have to pay federal unemployment tax. These payments may be made quarterly or annually, depending on how much is owed. In either case, businesses must file IRS Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return at the end of the year

State unemployment taxes

Employers typically pay state unemployment tax in every state where they have employees. In most cases, payments are due quarterly, but the rates and wage bases vary by location. A business’s particular industry and previous experience with unemployment claims may also affect its unemployment tax liability.

Employee wage and tax reporting forms

Although not a tax per se, failing to accurately complete wage and tax reporting forms or missing distribution deadlines can result in monetary penalties. For example, businesses are required to send Form W-2, Wage and Tax Statement to employees and Form 1099-NEC, Nonemployee Compensation to independent contractors by January 31 of the following tax year.

How to calculate payroll taxes

The IRS charges a flat rate for payroll or FICA taxes. Employers deduct 6.2% of employee gross wages for Social Security (until the wage base is reached) and 1.45% for Medicare. Combined, the total is 7.65%, which the employer must match. There is also an Additional Medicare Tax of 0.9% that applies to employee income above a certain threshold.

In addition, income tax and unemployment tax may have to be calculated each pay period. Income tax depends on employee withholding certificates and federal and state income tax brackets. Unemployment taxes also vary. Employers pay 6% federal unemployment tax on the first $7,000 that each employee earns, but may qualify for a credit up to 5.4% if they pay state unemployment taxes.

Penalties for not paying payroll taxes

Businesses that violate employment tax laws may be subject to:

• Monetary penalties
• Interest on back taxes
• Liens against property
• Civil and criminal sanctions
• Jail sentences

How much will an employment tax penalty cost?

The cost of employment tax penalties usually depends on several factors, including the type of infraction, the size of the business, how much is owed and whether payment was late or never received. Fees will also increase the longer that payments are past due.

Days Late	Tax Penalty
1 to 5 days	2%
6 to 15 days	5%
16+ days	10%
10+ days after the first IRS notice	15%

How do payroll tax penalties work?

The IRS levies the TFRP based on willful failure. Employers may be found willful if they were or should have been aware of outstanding taxes and either intentionally disregarded the law or were indifferent to its requirements. A common example is when a business has the funds to reimburse other creditors, but neglects to pay employment taxes.

Penalty exemptions

Businesses that receive a TFRP notice can seek abatement of the penalties by proving that there was reasonable cause for the unreported taxes or the late payments. Typical reasons can include:

• Fires and natural disasters
• An inability to obtain records
• Death and serious illness
• Unavoidable absence of the taxpayer or immediate family

Note that a lack of funds, in and of itself, is not considered reasonable clause. Employers must also provide documentation, such as a letter from a physician, a hospital or court record, or physical evidence of a disaster.

How to avoid payroll tax penalties

Employers can avoid employment tax penalties by improving their payroll processes so that all compensation paid to employees and all taxes withheld from wages are remitted and reported to government agencies on time. This is easier said than done, but the following advice may help:

Stay up to date with IRS announcements

The IRS regularly publishes news releases and tips that can help employers learn about updates to tax laws and new form submission deadlines. Businesses should also pay close attention to tax announcements in any states where they employ people.

Keep an employment tax budget

Failing to include payroll costs when planning a budget can lead to cash shortages and an inability to pay taxes. That’s why many businesses create a separate bank account just for payroll, which helps them better manage their tax withholdings and payments.

Use a payroll provider or full-service payroll software

Employers who want to not only cut their tax penalty risk, but also have more time to focus on strategic business initiatives often automate payroll processing. Full-service payroll providers, like ADP, can assist clients with calculating employee wages, withholding the necessary taxes and submitting them to government agencies on the business’s behalf. As a result, our clients often rest easy knowing that their wage and tax payments are both accurate and timely.

Frequently asked questions about payroll tax penalties

What is the penalty for late payment of payroll taxes?

If employers fail to deposit employment taxes with the IRS on time, they may be subject to the following penalties, depending on the number of days payment is past due:

• One to five days late results in a 2% penalty
• Six to 15 days late results in a 5% penalty
• 16 days late or within 10 days of the first IRS notice results in a 10% penalty
• 10 days after the first IRS notice results in a maximum penalty of 15%

What happens if you cannot pay payroll taxes?

Businesses that are unable to pay their employment taxes usually receive a notice from the IRS and a monetary penalty. If the taxes remain unpaid and the failure is determined to be willful, the IRS can place a lien on the employer’s assets or file criminal charges.

Who is liable for unpaid payroll taxes?

Anyone who is tasked with collecting and paying withheld employment taxes, such as an accountant or executive leader, may be held responsible for infractions. What’s more, the IRS does not limit its investigations to a single person and will prosecute everyone who it can prove played a role in the tax violation.

Will the IRS negotiate payroll taxes?

Under certain circumstances, employers who are unable to pay their employment taxes can settle their tax debt with the IRS for less than the full amount owed. To apply, they must submit Form 656, Offer in Compromise and all supporting documents that prove their eligibility. The IRS generally weighs their decision on the applicant’s income, expenses, asset income and ability to pay.

Is not paying payroll taxes a crime?

If the IRS determines that an employer willfully neglected to pay employment taxes, the individual could face civil and criminal sanctions, including imprisonment for up to five years.

This article is intended to be used as a starting point in analyzing an employer’s payroll obligations and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.

Tax figures provided are as of the 2021 tax year.