If you have employees, then payroll taxes are one of the costs of doing business. Unfortunately, they can also be a potential minefield. The IRS is cracking down on businesses that don’t properly file or report their payroll taxes – and they are paying especially close attention to small businesses, which are the largest source of uncollected taxes. Even if it’s an honest mistake, the IRS could leverage huge penalties, audit your company, and even initiate a criminal investigation if you do your payroll taxes wrong.
Below are some of the common payroll tax pitfalls that small businesses face, as well as suggestions on how to avoid them.
Pitfall 1: Late Deposits to the IRS
The IRS requires payroll tax deposits on a monthly or semiweekly schedule, and it’s up to you to determine which payment schedule you are required to use. Per the IRS guidelines, the schedule is based on your total tax liability as reported on Forms 941 or 944, and the process of figuring out your payment schedule can sometimes be confusing. However, if you pay on the wrong schedule, or miss your deadline for making your deposit, you could end up with a hefty penalty or, worse, on the IRS’s radar for an audit.
Pitfall 2: Borrowing from Withheld Funds
When cash flow is slow, it can be tempting to borrow from the money that you have withheld from employee paychecks, especially if you have a monthly payment schedule. The problem is that those funds don’t technically belong to the business, they belong to IRS. If you borrow those funds and aren’t able to pay them back when it’s time for you to make your deposit to the IRS, you will incur penalties. However, a bigger issue is that if the IRS finds out that you borrowed those funds, you could face heavy criminal and civil penalties, and you could be found personally liable for paying back all of that borrowed money.
Pitfall 3: Classifying Employees and Independent Contractors
One of the many advantages to hiring independent contractors is that you don’t have to pay payroll taxes. However, the IRS has very specific guidelines for what constitutes an independent contractor and if the people you hire don’t meet these criteria, then you can’t classify them as such. If you incorrectly classify your employees as independent contractors, and the IRS finds out, you could end up paying penalties, and be responsible for all of the payroll tax that was not withheld. You could also face criminal charges.
Pitfall 4: Depositing but not Reporting
There are two processes involved with payroll taxes: depositing the money to the IRS, or to the state and local agencies, and reporting what you owe on the necessary forms. If you make your deposits, but skip the reporting, you could end up paying some serious fines. The deadlines and schedules for reporting are different than the ones for deposits, so you need to stay on top of both processes.
Pitfall 5: Paying Taxes to the Wrong Locality
Your business doesn’t just have to pay federal payroll tax; they also have to pay state and local taxes. In situations where employees could live in one locality, but work in another, figuring out which taxes to pay for which employee can be difficult and confusing. Get it wrong, and you could end up owing a lot of money in fines and penalties.
Protecting Your Business
The best way to protect your business is to hire someone who has the skills and knowledge to handle your payroll taxes, and navigate the system for you. This could be a Certified Public Accountant, a tax expert, or a payroll company. ADP.com even has a MasterTax product that handles all of the payroll tax functions for you.
The advantage to having a qualified professional, or payroll service, handle your payroll taxes for you is that they can stay on top of the deposit and reporting schedules at the federal, state, and local levels, as well as stay on top of the ever-changing tax codes and regulations. These services can also save you money, not just in fees and penalties, but in the time that your payroll department would have to spend dealing with payroll tax issues.
Photo credit: Bonbon / Flickr