By Tayah E. H. Renfro, J.D., LL.M. (Tax)
Business owners and their advisors do not always understand the importance of paying federal employment taxes (known as “941 payments”) and paying those taxes on time. For example, Mike owns and operates a construction business. Like many other businesses, Mike’s business took a financial hit. As a result, he was forced to make some difficult financial decisions. Like many business owners in his situation, Mike paid the expenses necessary to keep his business afloat, but failed to remit his 941 payments each quarter. This is a mistake that many business owners make that not only results in harsh interest and penalties, but also can cost them their business.
Employers have a duty to withhold employment taxes from their employees’ wages. These withholdings include payments toward Social Security and Medicare. Employers withhold these amounts and pay a matching amount themselves. Currently for 2011, the employee tax rate for Social Security is 4.2%. The employer’s tax rate is 6.2%, for a total of 10.4%. The Medicare tax rate for both employers and employees is 1.45%, for a total of 2.9%. These payments are also known as “trust fund taxes” because the withheld amounts are held in “trust” by the employer until they are properly deposited with the IRS.
Trust fund taxes are unlike any other taxes or expenses a business owner is required to pay. Failure to deposit these amounts is viewed as theft because a business owner is using funds that belong to the IRS to pay for its own business expenses. If these taxes are not deposited when required, the business will not only incur harsh penalties and interest, but any responsible person will also remain personally liable for taxes even if the business dissolves. In addition, the IRS is authorized to apply the trust fund recovery penalty, which is equal to the full amount of the unpaid trust fund tax (often referred to as the 100% penalty).
When a business is so far behind in 941 payments, many business owners make the choice to dissolve the business, believing that all of the business debts and liabilities will disappear. However, unlike other business debts and liabilities, the 941 trust fund liabilities will attach to any responsible persons individually (including bookkeepers). The trust fund portion of the 941 tax liability does not disappear with the business; instead the trust fund portion becomes a personal liability. Just as the IRS may attach a lien and levy upon business assets, the IRS may attach a lien and levy upon the assets of a responsible person after a business has dissolved.
Therefore, business owners and their advisors need to appreciate the importance of 941 payments. Whether the business is striving or the business starts to struggle, advisors need to direct their clients to pay the 941 payments first before paying any other expenses. Likewise, employers just like Mike, need to resist the temptation to avoid or forget to deposit these taxes when the business takes a financial hit. For more detailed information, please refer to Publication 15 (Circular E), Employer’s Tax Guide, which may be found on the IRS website. If you have any questions or need assistance, please visit us at www.AdamsLawyers.com.
