Tax Controversy & Resolution: Payroll & Self-Employment Tax Debt Relief
Payroll (Employment) & Self-Employment Tax Debt Relief
Payroll taxes have the harshest penalty for failure to pay. Payroll taxes are usually withheld from employee earnings, which earmarks the cash for the IRS and prevents the taxpayer from using the amount for any other purposes.
The trust fund recovery penalty was enacted to encourage the prompt payment of withheld income and employment taxes, including Social Security and collected excise taxes. The trust fund taxes are composed of income taxes withheld plus the employee’s portion of FICA taxes withheld.
The penalty is imposed against any person who is responsible for collecting or paying withheld income and employment taxes and willfully fails to collect or pay them. A person is responsible if (s)he has the duty to perform and the power to direct the collecting, accounting, and paying of trust fund taxes. Because the business is withholding the employee’s money on behalf of the government, the penalty for not making payments is among the highest penalties on a percentage basis. The trust fund recovery penalty amount is 100% of the amount of trust fund taxes that were not paid. A federal tax lien may be filed against the responsible person.
Payroll (Employment) Taxes
If you have employees, you will likely need to file forms to report employment taxes. Employment taxes include the following items: (1) Social Security and Medicare taxes; (2) Federal income tax withholding; (3) Federal unemployment tax (FUTA).
In general, all employers are required by law to withhold applicable payroll taxes (i.e. Social Security, Medicare) and Federal unemployment taxes from their employees’ W-2 wages and remit the employees’ portion and the employers’ portion of payroll taxes to the IRS. Employers generally have the exclusive responsibility to withhold the specified amount from their employees' paychecks. If the employer does not remit the appropriate funds for the payroll taxes, the IRS may assess penalties and act to collect the payroll tax through various legal courses including levies, liens or garnishments.
On a quarterly basis, employers must generally file IRS Form 941 and remit the employees’ and the employers’ portion of payroll taxes to the IRS. An IRS Form 940 is also generally required and is filed at the end of the year for unemployment taxes which is paid by the employer.
Self-Employment Tax (SE Tax) consists of Social Security and Medicare taxes generally for individuals who work for themselves (self-employed). Self-employed individuals are generally required to file an annual return and pay estimated tax (i.e. SE Tax, income tax) quarterly.
Generally, you are self-employed if any of the following apply:
You carry on a trade or business as a sole proprietor or an independent contractor;
You are a member of a partnership that carries on a trade or business; or
You are otherwise in business for yourself (including a part-time business)
SE Taxes are similar to the Social Security and Medicare taxes withheld from the pay of most wage earners (e.g. employees). You must generally pay SE Tax if you had net earnings from self-employment of $400 or more. The SE Tax rate is determined as a percentage of your net earnings from self-employment. This rate consists of 12.4% for Social Security (old-age, survivors, and disability insurance) and 2.9% for Medicare taxes (15.3% total rate).
Approximately, the amount subject to SE Tax is 92.35% (1/2 of 15.3% employer portion deduction ~ 7.65%) of your net earnings from self-employment. Self-employed individuals may deduct the employer-equivalent portion of their SE tax in determining their adjusted gross income. However, hired employees (wage earners) cannot deduct Social Security and Medicare taxes. Self-employed individuals calculate net earnings by subtracting ordinary and necessary trade or business expenses from gross income derived from your trade or business using the Schedule SE (Form 1040). Note, a self-employed taxpayer may be liable for paying SE Tax even if receiving social security benefits. Although tax law provides a maximum amount of net earnings (changes annually) subject to the social security tax, all of your net earnings are still subject to the Medicare tax.
Self-Employment Taxes: Additional Medicare Tax
An additional Medicare Tax (0.9% rate) for hospital insurance applies to self-employment income above a certain threshold. The threshold amounts previously provided include $250,000 for a married individual filing a joint return, $125,000 for a married individual filing a separate return, and $200,000 for all others.
Quarterly Tax Payments Procedures
If you are required to file quarterly estimated tax, estimated tax is the method used to pay Social Security and Medicare taxes and income tax. Form 1040-ES, Estimated Tax for Individuals (Form 1120-W, Estimated Tax for Corporations) is used to determine these estimated taxes which leverages your prior year’s annual tax return in order to complete.
The Form 1040-ES used to estimated tax payments may be mailed or submitted using the IRS Electronic Federal Tax Payment System (EFTPS). If this is your first year being self-employed, you will need to estimate the amount of income you expect to earn for the year. If you overestimate your earnings, you may complete another Form 1040-ES worksheet to recalculate (lower) your estimated tax for the next quarter. If you underestimate your earnings, similarly, you may complete another Form 1040-ES worksheet to recalculate (increase) your estimated taxes for the next quarter.
Employer Failure to File Payroll Taxes
Failing to file or pay your payroll taxes may result in additional accruing penalties which may over time surpass even the amount of applicable income taxes owed by an individual. Moreover, the IRS may attempt to seizure company property (inventory, equipment), and the penalty may not be dischargeable in bankruptcy. Even more, if the resulting penalty is substantial enough, in some cases, it may even lead to criminal charges.
The person deemed responsible in the event that payroll taxes are not paid is a broadly defined and provides the IRS greater flexibility when attempting to collect. The IRS will analyze various factors among potentially responsible individuals including:
power to compel or prohibit the allocation of funds;
authority to sign the checks;
power to make the decisions regarding the disbursement of funds and payment of creditors;
officer(s) or director(s) of the corporation;
control of payroll regarding the company;
prepares and signs all payroll tax returns;
actively participates in the management of the day-to-day operations; and
responsible for the hiring and firing of all employees.
Regardless of the factors noted above, there may be applicable exceptions in allocating responsibility for payroll tax debts regarding non-owner employees performing ministerial acts without exercising independent judgment.
Correcting Employment Taxes
Depending on the taxpayer's situation, one option to resolve prior employment tax issues includes developing an accommodating repayment plan with the IRS so the taxpayer's business retains enough cash-flow each month to continue operations and keep current on future payroll taxes. Additional guidance and information, and IRS resources are also listed below.
File Any Outstanding Employment Tax Returns. In general, you may not negotiate your delinquent tax balance unless all tax returns have been filed.
Effective for errors discovered on or after January 1, 2009, the amended forms are used to report adjustments to employment taxes and to claim refunds of overpaid employment taxes. Employers should use the these amended forms to correct employment tax errors as soon as they are discovered. For example, use Form 941-X, Adjusted Employers Quraterly Federal Tax Return or Claim for Refund, to correct errors on a previously filed Form 941
When requesting abatement of assessed penalties and interest, the taxpayer should also file Form 843.
Revenue Ruling 2009-39 illustrates the application of the interest-free adjustment and claim for refund processes under the final regulations promulgated by Treasury Decision 9405 (TD 9405). TD 9405 amends the process for making interest-free adjustments of employment taxes under IRC sections 6205 and 6413, and claiming refunds of employment taxes under IRC sections 6402 and 6414.
Revenue Procedure 2017-28 provides guidance on the requirements for employers to obtain employee consents to support a claim for refund of overpaid Federal Insurance Contributions Act (FICA) and the Railroad Retirement Tax Act (RRTA) taxes. It clarifies the basic requirements for both a request for employee consent, and for the employee consent itself, and allows the consent to be requested, furnished, and retained in an electronic format. It also contains guidance concerning what constitutes “reasonable efforts” if employee consent is not secured in order to permit the employer to claim a refund of the employer share of overpaid FICA or RRTA taxes.
Ensure All Quarterly Payroll Tax Deposit Filings Up-to-Date. You may not generally negotiate your balance if you still have payroll tax deposits that have not been made for the current quarter.
Complete Form 433-B, Collection Information Statement for Businesses. This form outlining your financial status (business income, expenses and assets) is generally required to negotiate a payment plan to satisfy your past due taxes with the IRS. and calculate a reasonable amount of payment each month.
Retain Documentation Supporting Form 433-B. You must support your income / expenses documentation proving the statements in Form 433-B are accurate. These may include prior business bank statements, a year-to-date profit and loss statement(s), copies of monthly business expenses, accounts receivable aging report, recent payroll summary, and support of recent federal tax deposit payments.
Provide the Financial Support to IRS & Request Formal Installment Agreement. Your installment agreement request should state the proposed payment amount per month, the date the payments will initiate, and tax periods the installment agreement included.
Voluntary Classification Settlement Program (VCSP)
VCSP is a voluntary program that provides an opportunity for taxpayers to reclassify their workers as employees for employment tax purposes for future tax periods with partial relief from federal employment taxes. To participate in this voluntary program, the taxpayer must meet certain eligibility requirements and apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS. See also Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding
The IRS has established a voluntary administrative process to allow certain employment tax issues not involving worker classification to be permanently and conclusively resolved through a closing agreement program. The objective of this voluntary process is to reduce administrative burden by saving time and resources for both the IRS and taxpayers and to enhance voluntary compliance in limited situations. Under this administrative process, taxpayers must demonstrate that amended forms ("Form 94X-X") and other correction procedures would not allow for the prompt, permanent, and conclusive resolution of the issue(s). However, whether an agreement will be entered into is a matter within the IRS Commissioner's sole discretion. See Voluntary Closing Agreement Process – Employment Tax Issues (VCAP–ET).
Comply IRS Deadlines. Failure to comply with IRS deadlines may result in a garnishment against your business bank account or accounts receivable.
See IRS Tax Resources (Self-Employment Tax Forms & Small Business Tax Guides)