Avoid the Employment Tax Delinquency Trap
The IRS can assert personal liability for some withholding taxes. In today's economy, more and more companies find themselves trying to get by on reduced revenues and slim operating margins. When poor business conditions cause revenues to dwindle, banks may revoke essential lines of credit. Companies looking for a quick cash fix are easily lured into the trap of using withheld employment taxes--which should be remitted to the Internal Revenue Service (and to appropriate state agencies)--to fund critical operating expenses. The consequences of not paying withheld payroll taxes can be considerable. This article focuses on repayment strategies CPAs can recommend to help companies resolve delinquent federal employment tax problems. THE DELINQUENCY TRAP There are four types of employment taxes--two are "trust fund" taxes and two are "non-trust fund" taxes. The former two consist of employee federal income taxes and the 50% share of FICA taxes an employer must withhold from employee wages. Nontrust fund taxes are those owed by the employer-unemployment taxes and the employer's 50% share of FICA taxes. The employment tax delinquency trap is a double-edged sword. In addition to imposing stiff penalties and interest on delinquent employment taxes, under Internal Revenue Code section 6672 the IRS can assert personal liability (generally known as the 100% trust fund recovery penalty) for the trust fund portion of the delinquency on any and all responsible persons. A responsible person is anyone who has the power to ensure the trust fund taxes are paid on time. Responsible persons can include employees other than corporate officers and directors such as the controller, payroll manager or a bookkeeper. The IRS can assert and enforce personal liability for the trust fund portion against any number of responsible persons simultaneously and usually seeks to hold as many persons as possible liable. As discussed below, even bankruptcy does not provide an escape from this liability. Because the IRS is very aggressive in asserting the 100% recovery penalty, it is critical for CPAs to ensure that companies facing this problem retain attorneys well versed in the special legal issues involved who can advise them of the ramifications of the penalty assessment. DESIGNATE THE PAYMENTS Since individuals generally cannot be held personally liable for the non-trust fund portion of a company's delinquent employment taxes (or related interest and penalties), it is crucial to responsible persons that the trust fund portion (for which individuals can be held liable) be repaid as quickly as possible-before the non-trust fund portion. CPAs should advise companies they can pay off the trust fund portion first by designating specifically how payments against the delinquency should be applied. A word of caution, however. Since the IRS often does not favor designating payments, exercising judgement as to when to designate can be important to retain IRS cooperation in devising repayment strategies. Companies should use the following language--"Direct and apply to the remaining trust fund balance owed for the form 941 period(s) ending XX."__ * In a cover letter accompanying the payment. * On the back of the check as a restrictive endorsement. * On the memo line of the check. Form 941, Employer's Quarterly Federal Tax Return, is the form most employers use to report employment tax obligations other than unemployment taxes. If a company is uncertain which form 941 periods are delinquent, or of the outstanding trust fund balance for that period, the designation should instead be to the trust fund balance "for the most recent form 941 period(s) for which taxes are owed." Designation to the most recent periods can achieve additional benefits if a company owes employment taxes for multiple periods. Depending on the length of the delinquency, it may be preferable to repay the most recent periods first; under IRC section 6651, penalties for failure to pay the outstanding balance generally accrue at a rate of 1% per month for a maximum of 50 months. …