If a business you own or run fails to make timely payroll deposits according to schedule, it can be quite easy to find yourself with huge payroll tax penalties and debt with the IRS, which can feel impossible to resolve. If your payroll is even of modest size, you can quickly run up a payroll tax debt of six figures. What many business owners and comptrollers want to know is if there is an effective way out.
People often ask if the Offer in Compromise can be used on unpaid payroll taxes. The short answer is yes, but care must be taken to avoid a trap lurking. This trap can turn a solid way out of a tight spot into a horrific personal burden.
Federal Payroll taxes have two parts
The first thing you must understand is that federal payroll tax deposits have two parts: The employers' share and the employees' share. The employers' share can be around 25% of the total payroll amount — depending on the average wage of the employees on payroll. The employers' share of payroll taxes is the employers' portions of Social Security and Medicare. If you are self-employed, you would know these taxes as the dreaded self-employment tax. But, as employees are not self-employed, the employer must pick up the cost of these taxes. Employees typically have no idea that employers must pay an additional tax, but employers sure know.
For instance, someone who is paid $20 an hour — the employer knows he or she has to pay more than $20 an hour to employ them (legally, at least). The other part of payroll deposits is the employees' portion. This is the part employees actually see deducted from their gross pay which leads to their net pay. This employees' portion includes income taxes and the employees' portion of Social Security and Medicare. These are the taxes the employee puts down on their personal tax return to show the total withholding that an employer made on their behalf, and allows them to claim a refund.
But what happens when payroll taxes aren't paid? Are employees entitled to credit for taxes which the IRS was actually never paid?
You see, there is a difference between an employer claiming that payroll taxes were paid and those payroll taxes actually being paid.
The IRS will act as if they were paid fully for employee withholdings that they actually never received. An employee will usually not know that the IRS didn't receive their withholdings. It is this "employer portion" of the payroll tax that IRS gets rather agitated about not receiving. First, they didn't receive the taxes. Second, they had to pay out refunds on taxes they never actually got. This leads us to the trap regarding submitting an Offer in Compromise payroll taxes.
What is the IRS willing to forgive with an Offer in Compromise payroll taxes?
With an Offer in Compromise for payroll taxes, the IRS is willing to forgive that employers' portion — as long as the ability to pay for the business justifies it. The IRS simply didn't get the money — they didn't have the additional injury of having to refund money they didn't receive. Now here comes the trap with an Offer in Compromise payroll taxes: The IRS will forgive the employees' portion too! At least for the business! A business can lower its payroll tax debt with the IRS to a low amount — as long as the reason collection potential justifies it. So this is great, right?
No. The problem is that the IRS will then seek recovery of that employees' portion from people it feels are willfully responsible for not making proper payroll deposits. By submitting and having accepted an Offer in Compromise for payroll taxes less than the amount of the employees' portion (which, when it is assessed, is called the Trust Fund Recovery Penalty), all you are doing is moving a liability off a companies' balance sheet and putting it on a personal balance sheet. Wat's the problem with that?
- You will likely get no tax deduction for making those payments.
- If you file a joint return, your spouse may become liable (there are ways to fix this.)
- And all of your personal assets become subject to the tax debt.
When payroll taxes are owed, an IRS Revenue officer will seek to assess the Trust Fund Recovery Penalty (TFRP) during a 4180 interview. This is because they have a limited amount of time to do so, but it does not mean that they will be looking to collect personally while a business is making repayments or negotiating a settlement (but they may).
Bottom line for Offer in Compromise on Payroll Taxes for a running business
Be careful about making an Offer in Compromise on payroll taxes for less than the amount of the employee's portion or TFRP. If you are assessed the TFRP as a result of making this Offer in Compromise payroll taxes and the IRS is looking to collect personally because the business can't repay, be aware that there are solutions.
While you can file Chapter 13 repayment, I have never seen a repayment that has been better than what you can negotiate with the IRS directly. You can't file a Chapter 7 to discharge (we can think of possible exceptions, i.e., faulty assessment procedure) trust fund assessments. Yet, you can file a personal Offer in Compromise to settle a trust fund that has been assessed against you personally.
Offer in Compromise Payroll Tax Bonus Fact:
Do you know why employers are responsible for withholding taxes from an employee's pay? Because the IRS knows that if employees were responsible for sending checks every year for federal taxes, the IRS would actually collect not so much in the form of taxes. In 1943, Congress passed the Current Tax Payment Act, which required employers to withhold taxes from employees' wages and remit them quarterly.
By creating the withholding/refund structure, the IRS tricked people into thinking that filing taxes is a good thing — that's what you do to get a magical refund check. For most employees, tax day is not the uncomfortable day it is for those in business for themselves. So if you are feeling bad about yourself for not making full payroll tax deposits, just realize, it is only because Congress thinks you are more trustworthy than your employees.
