Why you must pay your payroll taxes

If your business runs payroll, that is, payments to employees that show up on their W-2, the IRS has some new regulations that you need to be aware of. 

I became aware of this in July by reading this article by Bloomberg Tax. 

From the article, this part caught my attention:

“Starting in June, the IRS has made it clear that its revenue officers will now be tracing where the unpaid payroll tax money actually went during their “trust fund investigation.” If it is determined that money went either to the owner or was spent for the owner’s benefit, the owner will now be facing a double whammy of the unpaid income taxes on those funds. In other words, if a business owner is pocketing payroll tax remittances to maintain a luxury lifestyle, it will more likely lead to prosecution.”

Scary? Yes, but only if you’re doing it wrong. To explain what I mean, let’s start with a simple explanation of how payroll works. 

How Payroll Works

Let’s say you have one employee and you pay her $1,000 per month. Now, as we all know, your employee doesn’t get a check for $1,000. Out of that $1,000, she owes 6.2% for social security and 1.45% for medicare. She also owes federal and state withholding. Those rates vary, so let’s just say her federal withholding is $200 and her state withholding is $100. So her net check will be $1000 minus $62 for social security, minus $14.50 for medicare, minus $200 federal withholding, minus $100 state withholding, which equals $623.50. 

In addition to owing your employee $1,000, your business will also owe the federal government 6.2% for the employer portion of social security and 1.45% for the employer portion of medicare. Two other taxes are FUTA - 0.6% for federal unemployment tax and some state unemployment tax (SUTA) as well. (In Arkansas, a new business pays 3.2% for that so we’ll use that number for now.) So on top of the $1,000 to the employee, your business will owe $62 for employer social security, $14.50 for employer medicare, $6 for FUTA and $32 for SUTA. 

So our total payroll for the month is:

• Net check to employee $623.50

• Federal withholding $200

• State withholding $100

• Social security - employee $62

• Social security - employer $62

• Medicare - employee $14.50

• Medicare - employer $14.50

• FUTA - $6

• SUTA $32

Total payroll cost: $1114.50

Remitting Payroll Taxes

Now, on payday, you direct deposit $623.50 into your employee’s bank account. What about the rest of the money? What happens to the $491 you owe in payroll taxes? Well, if you are running payroll yourself outside of a payroll service, that $491 stays in your business’s bank account until the payroll taxes are due. On the due date, each amount is paid to the appropriate taxing authority and everyone goes home happy!

But wait… What if, between payday and the tax due date, your business got low on cash? What if you needed to purchase some supplies to make your product but all you had in the checking account was the $491 that was reserved for payroll taxes? 

Now do you see where business owners get into trouble? 

Not paying your payroll taxes is stealing. Plain and simple. It’s stealing from the government AND, most importantly, stealing from your employees. On their W-2, your employees still get credit for their federal and state withholding payments even if the employer doesn't send them in. So the federal and state governments take the hit. 

Understanding the Threat 

What happened in June with the new IRS regulations goes one step further. Let’s say that, instead of needing to purchase supplies for your business, the owner wanted to take a weekend trip. They needed $250 for a hotel room so they took a shareholder distribution. Now, this is perfectly legal under normal circumstances. But if the IRS sees a pattern where the owner consistently takes distributions while not paying their payroll taxes, they are now going to go after the owner personally as an individual as well as criminally. In the past, unpaid payroll taxes were only subject to civil penalties. Now they will be subject to criminal penalties as well. 

The good news is that, if you use a payroll service such as Paychex, they draft the full amount of net checks and payroll taxes all at once. So you don’t have a chance to skip out on them. If you are my client and we run payroll through QuickBooks, I will monitor your cash flow and I won’t let you cancel the payroll tax payments. 

If you are struggling with cash flow issues in your business and struggling to pay these taxes, send me an email and let’s talk about getting your books in order so that you can get back on track and avoid this scary situation.