Updated: Jul 12, 2022
If you have at least one employee, you’re responsible for payroll taxes. These include withholding federal (and, where appropriate, state) income taxes and FICA tax from employees’ wages as well as paying the employer share of FICA tax and federal and state unemployment taxes. The responsibility is great and the penalties for missteps make it essential that you do things right. In fact, business owners can be personally liable for the unpaid wages and penalties resulting from even unintentional payroll mistakes.
1. Misclassifying workers Audits by federal and state wage labor regulators have been on the rise in recent years. Perhaps the hottest audit issue today is misclassifying workers. There’s incentive to treat workers as independent contractors rather than employees because payroll taxes and employee benefit costs are high; a company’s only tax responsibility for an independent is issuing a Form 1099-MISC if payments in the year are $600 or more. You don’t have the right to label a worker as an independent contractor; classification depends on whether you have sufficient control over the worker. This essentially means having the right to say when, where, and how the work gets done. Having an independent contractor agreement is helpful in showing that you and the worker do not intend any employer-employee relationships, but the ultimate decision is up to government regulators. Too many employers place unreasonable reliance on independent contractor agreements. There’s no need to guess about proper classification. There are plenty of resources available from the U.S. Department of Labor and the IRS.
2. Not using an accountable plan for employee reimbursements
If you normally pay for travel, entertainment, tools or other business costs for employees, you’re wasting employment tax dollars if you don’t use an accountable plan. With this arrangement, you deduct the expenses but avoid all payroll taxes on reimbursements; employees do not have any income from reimbursements. To be an accountable plan, the employer must formalize the arrangement and set reasonable times for action (the following times are reasonable to the IRS but you can adopt shorter time limits for action):
The reimbursable expense must be business related.
Advances cannot be made before 30 days of the expense.
Employees must account for the expenses within 60 days of the expense.
Employees must return excess reimbursements to the employer within 120 days of the expense.
3. Failing to keep payroll records
You are required to maintain payroll records and have them available for IRS and Department of Labor inspection. These include time sheets, expense accounts, copies of W-2s and other payroll records. Usually, you should keep information for at least four years. In the event of a tax or wage audit, these records are in valuable asset that you can use to defend yourself.
4. Choosing to pay creditors before the IRS
When a business gets into a cash crush, it may be tempting to pay the landlord, vendor, or utility company before the IRS and Pennsylvania Department of Revenue; bad idea! As a business owner, you are a “responsible person” who remains 100% personally liable for “trust fund” taxes (amounts withheld from employees’ wages). This is so even if your business is incorporated or is a limited liability company. Best strategy: set aside cash to cover payroll taxes so you won’t use these funds for any other purpose.
5. Failing to monitor payroll company activities
Many small businesses use outside payroll companies to handle the job of figuring withholding amounts as well as transferring funds to the U.S. Treasury and Department of Revenue to cover payroll taxes. However, some of these companies may not do their job, by error or intentionally. As an employer, even if you use an outside payroll company you remain responsible for payroll taxes. Best protection: Monitor your tax account to see that funds are being deposited on time and in the correct amount. If deposits are made electronically using EFTPS.gov, you can easily see activities in your account. Stay on top of your employer responsibilities to avoid any penalties or entanglements with the government regulators and employees. The attorneys on our business team, Michael E. Fiffik, Esquire, and Matthew A. Bole, Esquire can answer your employment questions.
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