Tough Penalties on Payroll Taxes (and How to Avoid Them)

Becoming a small business owner is always filled with surprises. Despite all of your best laid plans, there are always unexpected snafus, as well as successes. And, really, this is part of the makeup of an entrepreneur, an ability to adjust to changes and new opportunities.

Unfortunately, one of the surprises many small business owners face early on is that when payroll is not handled properly, the penalties can be quite costly. Last year, business owners faced $4.5 billion in payroll tax penalties, according to the IRS.

Payroll taxes withheld from wages is one prime example.

Payroll taxes
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In a recent Forbes column, tax litigation expert Robert W. Wood explained that when a business owner has a tax shortfall – often no matter what the reasons – the IRS will typically fine everyone with an ownership interest in the company.

In what’s called a Trust Fund Recovery Assessment or a 100 percent penalty, all of the owners, check signers and/or officers may have to pay. If Social Security, Medicare and income taxes are not collected and paid, according to the IRS, you may be personally liable for the trust fund recovery penalty. In extreme cases, Wood adds, the federal government seeks criminal penalties.

Now this is most likely rare, however it’s a reminder of the seriousness with which small business owners should approach payroll.

Failure to deposit payroll taxes on time is another issue. Penalties on late payments start at 2 percent of the unpaid tax and can get as high as 25 percent.

Do note, though, that if you receive a penalty notice, you can provide an explanation of reasonable cause for not paying.

Managing payroll taxes

Lessons learned

The lesson in all this doom and gloom: Make paying payroll taxes correctly a priority at your company. One of the best ways to do so is to automate the process with an online payroll service that calculates, files and pays all of your federal, state and local payroll taxes on your behalf.

You may want to cut costs by doing the payroll yourself, but be aware it can become an increasingly complicated process when you get into obscure state and local laws, as well as just the labor of making the proper calculations for things like 401(k) contributions and overtime pay.

You’re going to be dealing with curveballs in all kinds of areas with a new business – you’ll work more efficiently if payroll is one thing that’s automated. Then you can focus on your business model, hiring and training employees, and seeking new opportunities – areas where you can learn from your mistakes, rather than just being penalized for them.