One of the most notorious tax debts you may incur is payroll taxes. If you have to owe the IRS any taxes it has to be something other than payroll taxes. The IRS looks upon such taxes as though you not only didn't pay your own taxes but you delved into the US Treasury and took money from it. That explains the usual anger behind the payroll tax problem that the IRS expresses when your CPA or tax attorney tries to negotiate a tax settlement for them.
It may help to start at the beginning. When you start your business, you may or may not encounter payroll tax issue. If you are an insurance agent or a plumber that works by himself with no employees, all you need to do is report your taxes on Schedule C at the end of the year. You are self employed (not a corporation). In these instances you don’t have employees to worry about their payroll taxes.
The only employee you need to watch is yourself. You will pay your social security taxes when you file your income taxes at the end of the year or through estimated tax payments if you expect a big tax liability at the end of the year.
The social security tax rate for self employed is 15.3% which represents your share as an employee (7.65% or ½ of the 15.3 %). You also match the 7.65% as an employer on yourself. So you wear two hats; one as an employee for which you pay 7.65% and the other as an employer who matches the social security taxes for his employee by another 7.65%. Thus the total is 15.3%.
If you work alone in this manner, you do not need a federal tax ID number, your social security number is sufficient. If you decide to incorporate however, and you are the only employee then you will need a federal ID number.
Let us assume for our purpose that you are a corporation with employees and have a federal ID number. Every payroll period, whether weekly or otherwise, you deduct from your employees basically two taxes (assuming no state taxes). You deduct whatever federal income tax they should pay and also you deduct 7.65% of the wages for social security and Medicare. After you do that you must match what you took from each employee for social security. Your matching share is again 7.65%.
What do you do with the money that you have in your custody? To remind you, you have three parts of monies, the first is the income tax withholdings, the second is the employee's share of social security and the third is your matching as an employer.
You take this money and you deposit them in your bank for the benefit of the IRS. The IRS gives you a coupon book. You use the slip along with the money. The bank transmits the money to the IRS and you get the credit for the payments. At this point we are even with the IRS with no tax problem.
Again, once more let us look at the money that you just deposited in the IRS account at your bank. Two components were paid by the employees; they are tax withholdings and their share of social security and you are merely an agent that should deliver this money to the IRS. The third component is your money which represents matching the employee social security.
If you don’t deliver this money to the IRS, you have, in essence, kept the money that your employees paid you to deliver to the IRS in addition to your matching share. At the end of the year after the employees do their tax return and if they are due a refund that the IRS must pay them because the IRS is supposedly returning to the employees the money that the IRS received from them. You see the problem? The IRS must pay money to the employee back for something they never received. Now do you see why they get mad?
Some have tried to avoid paying the employee so that they may not fall into the trap of owing payroll taxes to the IRS. Does that sound like a fair and honest solution? It may sound like that to you and me but not to the IRS.
If you tried to treat your employees as self employed or contract labor, you will be almost as in trouble as was the case when you kept the IRS money. The tax problems that you will suffer from are one of defining what contract labor is and what an employee is.
If we classify your employees as contract labor and the IRS comes three years later and discovers that they should have been classified as employees you should brace for some taxes. Some owe enough taxes to put them out of business. If you have a restaurant and you have a payroll $500,000 a year, your liability could be over $200,000 in those years. When you add penalty and interest it could exceed $300,000; enough to close such business. Payroll is serious.
To summarize, if you don’t deposit your tax liability, you have a major tax problem. If you try to convert your employees into contract labor, you may just be in as much heap as the latter. Best thing is to play by the book. In doubt consult your CPA, enrolled agent or tax attorney.