During the COVID-19 pandemic, some cash-strapped employers may fail to pay the U.S. Treasury the federal income and employment taxes their organization withheld from employee paychecks. The IRS issues a 100% penalty against any person deemed responsible for this major tax faux pas.
Thankfully, the Coronavirus Aid, Relief, and Economic Security (CARES) Act grants some meaningful federal payroll tax relief for this year to help prevent this issue. It allows employers to defer the 6.2% employer portion of the Social Security tax component of FICA tax owed on the first $137,700 of an employee’s 2020 wages.
Remember though, employers must follow the guidelines correctly if they choose to defer the tax. Those who fail to pay taxes that were withheld from employee paychecks will be held responsible for the entire unpaid federal payroll tax amount. The logic behind the 100% penalty is that the federal government should be able to collect withheld, but unpaid, federal payroll taxes from unscrupulous individuals who had control over an employer’s finances. The following identifies who may be considered responsible in the event withheld taxes are not paid to the U.S. Treasury.
Considerations in Determining a Responsible Person
The 100% penalty can be assessed only against someone deemed a responsible person. There are many who could assume this title:
• A shareholder, director, officer, or employee of a corporation
• A partner or employee of a partnership
• A member (owner) or employee of a multi-member limited liability company (LLC)
The 100% penalty can also be assessed against an employee of a sole proprietorship or an employee of a single-member (one owner) LLC.
To be hit with the 100% penalty, an individual must meet the following two criteria:
1. Be responsible for collecting, accounting for, and paying over withheld federal taxes, and
2. Willfully fail to pay over those taxes.
The term willful means intentional, deliberate, voluntary, and knowing — as opposed to accidental. The mere authority to sign checks when directed to do so by a higher-up doesn’t establish responsible-person status. There must also be knowledge of and control over the finances of the business.
The IRS will look first at individuals who have check-signing authority. However, you can’t deflect responsible-person status by simply assigning signature authority over bank accounts to someone else. To determine responsible-person status, the IRS also may consider whether the individual:
• Is an officer or director,
• Owns shares or possesses an entrepreneurial stake in the company,
• Is active in the management of day-to-day affairs of the company,
• Has the ability to hire and fire employees,
• Makes decisions regarding which, when, and in what order outstanding debts or taxes will be paid, and
• Exercises daily control over bank accounts and records of disbursements.
In certain circumstances, outside parties — such as lenders, attorneys, and accountants — can also be responsible persons.
For example, a tax attorney who actively participated in managing the finances of several corporations in which he had invested was found to be a responsible person. He also had check-signing authority and previously exercised his authority as a corporate officer to correct the corporation’s failure to pay over employment taxes.
However, situations involving outsiders don’t typically occur. In most cases, people inside the company receive the 100% penalty.
For example, a corporation’s newly hired CFO became aware that the company was several years behind on its payroll taxes and notified the company’s CEO of the situation. The CFO and CEO then informed the company’s board of directors.
Although the company apparently had sufficient funds to pay the taxes, no payments were made. After the CFO and CEO were both fired, the IRS assessed the 100% penalty against them for withheld but unpaid taxes that accrued during their tenures.
In another case, the IRS ruled that a volunteer member of a charitable organization’s board of trustees was a responsible person. Why? The volunteer had 1) knowledge of the organization’s tax delinquency, and 2) the authority to decide whether to pay the taxes.
Likewise, the president of a daycare center’s board of directors was found to be a responsible person — even though he wasn’t paid for his work and wasn’t involved in day-to-day operations. Because he secured loans for the center, directed its tax payments, and reviewed its financial reports, he received the penalty.
Does the 100% Penalty Apply to Self-Employed People?
If you’re self-employed, you’re not exposed to the 100% penalty issue unless you have employees. But you’re effectively exposed to a 100% penalty for any unpaid federal self-employment (SE) tax. Plus, you’ll be hit with an interest charge penalty if your quarterly estimated federal income tax payments don’t cover your SE tax bill.
Under the CARES Act, self-employed people can defer half of the 12.4% Social Security tax component of the SE tax for the deferral period, which began on March 27, 2020, and will end on December 31, 2020. The 12.4% Social Security tax hits the first $137,700 of 2020 net SE income.
Self-employed individuals must pay the deferred SE tax amount in two installments:
1. Half by December 31, 2021, and
2. The remaining half by December 31, 2022.
More Information
When you participate in running an organization that hasn’t paid over withheld federal payroll taxes, you run the risk of the IRS classifying you as a responsible person. If that happens, you could personally be assessed a 100% penalty. Consult a Hantzmon Wiebel tax advisor about what records you should keep and what actions you should take (or not take) to avoid exposure to the 100% penalty.
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Our firm provides the information in this article for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisors. Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this blog are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability and fitness for a particular purpose.
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