Personal Liability Risks for Business Owners: Unpaid Wages and Payroll Taxes
Business owners may face unforeseen personal liability risks related to unpaid wages and payroll taxes. In this article, we'll explore the potential dangers and consequences associated with these issues, shedding light on the importance of vigilance and compliance.
Unpaid Wages
Pennsylvania wage and hour laws mandate timely payment of wages and fringe benefits. When employers fail to pay wages when due, it’s not always due to some intentional scam like the owners of the popular South Philadelphia cheesesteak joint, Tony Luke’s, were perpetrating. Even unintentional errors can expose business owners to personal liability, such as:
Wage Miscalculations
Someone to whom payroll has been delegated is making mistakes, intentional or unintentional, in your workers’ wages and the owner is entirely unaware.
Misclassification of Workers
A worker is misclassified as either an independent contractor or an employee exempt from overtime rules.
Violation of Work Rules
Workers are not paid for all of the hours they worked because they failed to document the hours they worked. (It’s the employer’s legal obligation to pay for all hours worked, regardless of whether a worker violates a company rule.)
Unlawful Deductions
Deductions not authorized by law are taken from a worker’s wages.
Many business owners are surprised to learn that even if their business is a corporation or a limited liability company (LLC), they may be personally liable for wage claims filed by their employees. The liability protection they assume is built into these entities does not protect their personal assets when it comes to unpaid wages.
If the worker files suit against their employer and is successful, the worker is entitled to an award of attorney’s fees in addition to back pay and liquidated damages. What this means for the business owner is that if they’re sued over wages, it could be a very expensive lawsuit because they’ll be paying not just their lawyer but also the employee’s lawyer. It is crucial for owners to stay informed and address any wage-related issues promptly.
Payroll Taxes
Employers are required to withhold from an employee’s wages income taxes (Federal and State) and the employee’s share of FICA (Federal Insurance Contributions Act) taxes. The Internal Revenue Code makes the employer a “fiduciary” of the United States with respect to these payroll taxes. When an employee’s income taxes and share of FICA taxes are withheld from the employee’s wages by the employer, the employee is treated as having paid those amounts to the IRS, whether the employer actually pays over such amounts to the IRS. This protects employees if the employer never pays over such amounts. The failure of other personnel in a company to pay over to the IRS withheld employment taxes, even if you are unaware of such failure, can result in personal liability for you.
Employers experiencing cash flow problems sometimes fail to pay the payroll taxes, choosing instead to use the cash attributable to those taxes to fund operations or pay themselves. This is always a bad idea. If an employer’s business ultimately fails and cannot pay the IRS the payroll taxes, the IRS, under the authority of IRC §6672, will seek to collect the withheld taxes from any “responsible person” of the employer (e.g., an officer, director, shareholder or bookkeeper with signature authority over a bank account.) This personal liability for “responsible persons” can be substantial. Moreover, in some cases, the IRS and the Department of Justice may seek criminal prosecution (as the owners of Tony Luke’s found out the hard way).
For personal liability to be imposed against an individual, three conditions must be met.
The individual qualifies as a “responsible person;”
The individual fails to collect or account and pay over the payroll taxes; and
The individual acts willfully in doing so.
It is much easier to meet these conditions than one might think.
To be a responsible person, the question is whether the individual had authority required to exercise significant control over the business’ financial affairs, regardless of whether they exercised such control in fact. If this standard is met, it is irrelevant that an individual’s day-to-day function is unconnected to financial decision-making or tax matters. It does not matter that payroll was not your job in the business. If you have apparent authority over financial matters, whether exercised or not, then you can be deemed a responsible person.
For nonpayment to be willful, there must be either knowledge of nonpayment or reckless disregard of whether the payments were being made. A reckless disregard of whether the payments were being made can be established even if the responsible person has no knowledge that the payroll taxes were not being paid. You cannot assume the payroll taxes are being paid. You cannot plead ignorance.
How Should Business Owners Protect Themselves?
If you are a business owner, or even a partial owner, you should assume that you could be deemed a responsible person for purposes of personal liability for unpaid wages and payroll taxes.
Understand Company Policies: Familiarize yourself with the company's wage payment policies.
Employee Classifications: Ensure all employees are correctly classified, avoiding potential issues with independent contractor arrangements.
Accurate Wage Calculations: Verify the accuracy of wage calculations and maintain precise records of employee work hours.
Timely Wage Payments: Ensure wages are paid promptly, complying with pay period schedules.
Regular Tax Remittances: Confirm the regular remittance of payroll taxes to federal, state, and local authorities.
We Can Answer Wage and Payroll Questions
Vigilance is key for business owners to prevent personal liability risks related to unpaid wages and payroll taxes. The experienced team of small business attorneys at Fiffik Law Group have over 40 years of experience helping business owners with wage and payroll issues. We can review your wage payment policies and employee classifications and advise you whether you are compliant with federal and state law. If you need any assistance with a wage claim or payroll tax issue, contact us at (412) 391-1014 for a fee initial consultation.