What Happens if You Misuse “Withheld” Payroll?

Article Posted on 05/15/2019

Occasionally we are approached by clients with low operating cash and that are unable to borrow from banks or other conventional sources. Without quick infusions of funds, they’ll likely go under.  In this situation they can’t pay suppliers and may not even be able to make payroll. 

What happens in this situation?  The owners fail to remit the taxes that have been withheld from employees and do not pay the employers share of FICA and Medicare.  They feel that they are just “borrowing” from the IRS.

They won’t be able to pay skittish suppliers who refuse to extend additional credit, even if the brothers guarantee payment. Nor will they be able to pay employees. Many of these workers have high salaries and possess skills that are hard to replace in a tight job market. The ones who jump ship will readily find work with competing companies.

While my future clients were foraging for funds, they encountered a person I’ll call Curly, someone who recently ended a stint as a low-level White House staffer. Curly continually touted his tax expertise and ties to politicians.

The brothers were so awed by their new acquaintance that they gave him a high, five-figure payment for a strategy that he’d imparted to lots of other cash-strapped businesses: Have their companies pay employees their net salaries but not remit hefty amounts of withheld income taxes and Social Security taxes to the IRS. Instead, use that money to satisfy suppliers. After all, as Curly assured the brothers, just as soon as business inevitably picks up, the companies can repay what they had “borrowed” from the IRS.

Unfortunately, this is not the case.  There is a long-standing law that empowers and encourages the IRS to act firmly and swiftly against companies that withhold taxes from pay checks but fail to pass them along in a timely manner.  The law is that the withheld money is not the business owners but rather money held “in trust” to be deposited with the IRS.  These businesses may think they’re doing nothing dishonest when they dip into the withholding kitty to make up temporary cash shortfalls. But many thousands of individuals who’ve played games with withheld taxes have been stunned to discover that their failure to pay such taxes made them personally liable—and that the IRS could grab funds in their personal bank accounts and retirement plans or seize other personal assets.

Not only that, the IRS routinely assesses penalties equal to 100 percent of the amounts due against the people who are responsible for collecting or paying withheld taxes and who “wilfully” fail to collect or pay them.

How does the IRS define “responsibility”? Responsible persons include:

  • Officers or employees of corporations
  • Members or employees of partnerships
  • Corporate directors or shareholders
  • Members of boards of trustees of non-profit organizations
  • Other individuals with authority and control over funds to direct their disbursement

Generally, the agency pursues the owners or top officers of organizations. The official policy is not to assert the penalty against "non-owner employees of the business, who act solely under the dominion and control of others, and who aren’t in a position to make independent decisions on behalf on behalf of the business entity." Employees in this grouping include secretaries, clerks and bookkeepers.

How does the IRS define “wilfulness”? It only requires a conscious, voluntary act.  This means that if you don’t remit the money it does not make any difference that you intended to later pay.  You can even be penalized if you simply forget. 

So big deal.  If the IRS goes after me I will file for personal bankruptcy.  No, no, no, that does not relieve you of responsibility for your company’s failure.

Kopsa Otte
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