Several years ago, I met with a SCORE client who was in the midst of a business crisis. On a regular basis, the client transferred funds to his accountant for submission to the IRS. Unfortunately, the accountant was spending the money and the client was in default.
It was many months before the client heard from the IRS, and by that time, interest and penalty charges were mounting. In addition, because the money had been given to the accountant, there was no money in the account to pay the IRS.
Cases like this, or situations where a business is desperate and diverts taxes taken out of employees' paychecks to pay for other expenses, can result in a situation from which the business might not recover.
That business owner would have benefitted from a new initiative launched by the IRS in December. The Early Interaction Initiative was designed to more quickly notify employers who are falling behind on their payroll or employment taxes. It also provides for assistance in getting them caught up on their payments.
Jim Fitzpatrick, a retired CPA and Green Bay SCORE volunteer, believes that the initiative is a step in the right direction. As a former business owner, he has experience with the complexity of the system and encourages businesses to follow regulations closely.
He advises, "I strongly recommend collecting, reporting and paying payroll taxes as required by Federal and State laws. The penalties for not doing so are severe. If an employer fails to deposit, penalties can range from 2% to 15% of the amount not deposited depending on the number of days delinquent. In addition, failure to file the required form 941 could result in a penalty of 5% for each part of whole month delinquent up to 25%."
These penalties quickly mount up. Before the new initiative, it was common practice for the IRS to wait until much later in the process to contact employers. Typically, that was after the employment return was filed; when the tax obligation may have already spiraled out of control.
As Fitzpatrick will attest, part of the issue is the complexity of the law. An employer must withhold Federal, State, Medicare, and Social Security taxes from employees' checks. These amounts must be submitted on a periodic basis as determined by the size of the business and amount withheld. Unless the business is very small, it is generally submitted shortly after employees are paid.
The issues arise when a business either doesn't follow instructions or is in a financial crunch and dips into those funds. What should a business do if it finds itself in this situation?
"The obvious answer is to never let that happen," Fitzpatrick said. "The amount withheld is not the employer's money and should never be used for any other purpose than to be deposited according to the law."
With changing regulations, Fitzpatrick said that payroll is usually not a core competency for most business owners. When he owned his business, the payroll processing and payroll deposits were the first functions that he out-sourced.
"There are many companies that specialize in payroll processing and do so for a reasonable cost. I would suggest that if an employer decides to use an outside service that making the payroll deposits are included. That pretty much eliminates any temptation to use that money for any other purpose," he commented.
Along with hiring a reputable payroll service or accountant to make deposits, the IRS initiative will help businesses avoid the situation that my client was in. The new notification system, with alerts sent as soon as 15 days after a payment is late, would have provided notice before the accountant put the business into a situation where recovery was impossible.
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