Employment Tax Deposit Penalties

Tax deposit penalty

If taxes are not deposited timely or in the correct amount, the IRS will impose a deposit penalty.

Penalties are generally based on a percentage of the unpaid tax liability.

Late deposit penalty amounts are determined using calendar days, starting from the due date of the liability.

The penalty rates are:

  • 2% - Deposits made 1 to 5 days late.
  • 5% - Deposits made 6 to 15 days late.
  • 10% - Deposits made 16 or more days late. Also applies to amounts paid within 10 days of the date of the first notice the IRS sent asking for the tax due.
  • 10% - Deposits made at an unauthorized financial institution, paid directly to the IRS, or paid with your tax return (see exceptions next).

Order in Which Employment Tax Deposits Are Applied

Deposits are generally applied to the most recent tax liability within the quarter. If you receive a failure-to-deposit penalty notice you may designate how your deposits are to be applied to minimize the amount of the penalty if you do so within 90 days of the date of the notice. Follow the instructions on the penalty notice you receive.

For example, the penalty for late payment of trust fund taxes (social security, Medicare, and federal income taxes) can be as much as 100% of the liability. So, if you're late paying trust fund taxes you can have your tax deposit applied to these taxes before any other taxes you may be late in paying. Attach a statement indicating this preference.

IRS Cracks Down on Misclassification of Workers

The IRS is well aware of the ploy by some employers to misclassify workers as independent contractors, who are responsible for their own taxes, rather than employees, where the employer is responsible for payroll taxes (i.e. social security, Medicare taxes, and FUTA taxes).

IRS Puts the Squeeze on Violators!
In the past, the IRS has teamed up with more than half the states to put the squeeze on worker classification violators. These violations are taken seriously by the IRS. Harsh financial penalties are part of their arsenal to discourage potential violators. Criminal prosecution is also on the table for knowingly and intentionally violating the rules.

The Worker Misclassification Ploy and How it "Saves" Money

There are two basic classifications of workers:

  1. Employee
  2. Independent contractor

Employee vs Independent Contractor:

When a worker is classified as an employee, the employer is responsible for withholding federal income taxes, social security taxes, Medicare taxes, and state income taxes (where applicable) from the employee's gross pay.

The employer is also responsible for paying one half of the total social security and Medicare tax liability (employee and employer each pay half).

In addition to social security and Medicare taxes, the employer is also liable for:

  • Federal unemployment taxes (FUTA) up to the first $7,000 for each employee
  • State unemployment taxes (SUTA) for each employee.
  • Worker's compensation insurance, which is required by state law

Note that employees are not liable for FUTA taxes or worker's compensation insurance. Only the employer is obligated to pay these items. There are some states that withhold state unemployment taxes (SUTA) from employees' wages.

When a worker is classified as an independent contractor, the business owner simply writes a check for services rendered and issues Form 1099-MISC annually to each independent contractor who is paid $600 or more during the tax year.

The business owner avoids paying what would be his share of social security and Medicare taxes. The employer also avoids paying FUTA taxes, SUTA taxes, and worker's compensation insurance; these taxes are employer-paid only.

Administrative Costs:

In addition to saving tax dollars, if a business classifies its workers as independent contractors, it avoids the cost of administering a payroll system and complying with employment tax rules, such as filing employment tax returns and depositing employment taxes with the government.

When you add it all up - the savings are quite significant to misclassify workers as independent contractors. However, the risk is also significant, including stiff penalties and potential criminal sanctions.

Using a Payroll Service is a Smart Move!

If you already have employees or plan on hiring and don't currently use a payroll service, using one can be a very smart move. Using a payroll service is a low cost way of getting your payroll done accurately and timely. And wondering if you have complied with employment tax rules won't keep you up at night.

A payroll service will prepare employment tax returns and ensure they get filed on time. You can also have the service prepare the paychecks and deposit payroll taxes.

What Determines the Employment Status of a Worker?

CONTROL is the key factor in determining the proper classification of a worker.

If the employer controls the means and methods for carrying out the work and sets the pay scale and work schedule for a worker, the worker is an employee.

On the other hand, if the worker controls how, when, and where the work will be done, sets the fee schedule, advertises and promotes the business to secure clients and develop a brand (i.e. operates a website and does offline promotion), has business letterhead, purchases and uses his own business equipment and materials, then the worker is an independent contractor.

For example, some employers hire a bookkeeper to work full-time on the business's premises (an employee) while other small businesses find it more cost effective to hire a monthly bookkeeping service (an independent contractor).

More information about independent contractors

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