Business owners must withhold federal and FICA contributions (Social Security and Medicare) from employee wages. The withheld funds are paid to a depository bank that collects the funds on behalf of the Treasury Department. The deposit is monthly or quarterly. IRS forms 940 and 941 must be filed. These are commonly known as payroll taxes or employment taxes.
Payroll taxes are the nuclear bomb of taxes. When a business has financial difficulties, the IRS is the one creditor that is the least demanding—at least initially. As a consequence, the other creditors tend to get paid first, like suppliers, landlords, and banks, all to the detriment of the IRS. But if the business fails, payroll taxes are one of the few business debts that are not dischargeable in bankruptcy. For that reason, it’s the one expense that should be paid first.
Further, personal liability attaches to every person in the business “responsible” for the nonpayment. It is not uncommon for the IRS to determine that half-a-dozen individuals are responsible for the nonpayment. This personal liability is known as the 100% Payroll Penalty. It’s called the 100% Payroll Penalty because each responsible person is liable for 100% of the tax regardless of the person’s level of responsibility for the nonpayment. And, like the tax, the penalty is not dischargeable in bankruptcy.
All individuals, even low level employees, can be liable for the 100% Payroll Penalty if they:
- Made financial decisions for the business;
- Had authority to sign checks;
- Had the power to direct payment of bills; or
- Had the duty of reporting taxes.
Pity the taxpayer liable for the 100% Payroll Penalty. The IRS considers this to be the most serious of all tax liabilities. The IRS is notoriously difficult when dealing with payroll taxes and penalties. Professional advice is strongly advised, particularly if the IRS has wrongly determined that an individual was a person responsible for the failure to pay payroll taxes—a determination that happens with surprising regularity.