To be viable, businesses have to pay for their operations and, after-tax, produce a profit or return. The tax burden can make it very difficult to produce a profit.
This is particularly true when sales taxes and payroll taxes are considered. The sales tax is imposed on the transfer of property (and in some states like Texas, that imposes sales tax on certain services). The payroll tax is charged on providing labor and receiving the benefit of the labor.
Most businesses have financial ups and downs. The financial downs can result in late-remitted sales and payroll taxes. The resulting delinquencies can compound if the financial downturn remains for an extended period. The state and IRS impose penalties on these late payments. They both impose interest as well. This can result in businesses getting into a financial hole that can be very difficult to dig out of. The ensuing payroll disputes can result in businesses having to close their doors.
This is why the penalty relief provisions for these taxes are so important. For payroll taxes, Congress has recognized this by providing relief from penalties in some situations. Congress provided this type of relief in the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”). The CARES Act was enacted in 2020 and affords taxpayers additional time to remit payroll taxes.
There are a lot of businesses that are hoping to rely on the provisions in the CARES Act to delay paying their payroll taxes. Many of these businesses may be surprised to learn that they are not going to get the penalty relief they are expecting for late payments. The IRS addressed this in Chief Counsel Memorandum 104274-21.
Payroll Taxes, Generally
An employer is generally required to charge and collect payroll taxes on wages paid to employees. The employer is then to pay these taxes over to the IRS. These employee-withheld payroll taxes are referred to as trust fund taxes as the employer collects and holds the taxes in trust for the Federal government (there is a separate penalty on the business owner if the business fails to remit these taxes).
They are also required to pay payroll taxes on the same wages. This non-trust fund portion is also remitted to the IRS.
The employee and employer portions are typically remitted by the employer to the IRS either monthly or quarterly. Some smaller businesses are allowed to remit the taxes to the IRS annually. Some very large businesses have to remit taxes daily.
The taxes are reported to the IRS on Form 941 (or for smaller annual pay employers, Form 944). Forms 941 are to be filed one month after the end of each quarter.
The Late Deposit Penalty
Section 6656 provides for a failure to deposit penalty for employers that do not timely remit payroll taxes to the IRS.
The penalty generally applies if payroll taxes are due, but not paid to the IRS within 10 days of the due date.
The amount of the deposit penalty is:
- 2 percent if the failure is for not more than 5 days,
- 5 percent if the failure is for more than 5 days but not more than 15 days, and
- 10 percent if the failure is for more than 15 days.
The amount can increase to 15 percent after certain notices are sent to the taxpayer.
Late Deposit Penalty Relief in the CARES Act
The CARES Act allows employers to defer paying the non-trust fund portion of their payroll taxes for 2020 and 2021. Specifically, the CARES Act allows the employer to remit these taxes annually rather than daily, monthly or quarterly. The CARES Act requires these taxes to be paid by the last day of the calendar year.
The question addressed in the IRS memorandum is how to apply these rules if the employer pays part of the taxes due by the end of the year, but not all of the taxes. Does the late deposit penalty apply to the portion that is unpaid or to the entire amount?
The IRS memorandum concludes that the penalty applies to the entire amount:
CARES Act section 2302(a)(2) conditions the deferral of deposits on the deposit of all deferred amounts by the applicable installment due dates. Specifically, the deferral of the deposits is valid provided “all such deposits are made not later than the applicable date.” If any portion of the deposit is not made by the applicable date, whether December 31, 2021, as to the first installment, or December 31, 2022, as to the second installment, then the deferral is completely invalid. In that event, the deposits were due on the usual deposit due dates provided in Treas. Regs. §§ 31.6302-1 and 31.6302-2, which would be the due dates used in determining any penalties under section 6656.
This means that even $1 of late payments voids the deferral and triggers the late deposit penalty on the entire amount of the tax–including the tax that was timely paid before the extended due date.
This is particularly troubling in that employers frequently have small discrepancies in their payroll taxes. Those who own or operate businesses will understand this. The IRS often sends notices and letters for nominal amounts for payroll tax discrepancies. This is very common. They are also usually due to IRS processing errors or mistakes made by bookkeepers. Some employers receive these every month or every quarter and they just pay them given that the amount is so small that the cost of correcting the IRS error is more than the amount of the penalties. This is just viewed as a nuisance by employers or a cost of doing business in a country with an inefficient government collector.
Other Options for Penalty Relief
The IRS memorandum’s conclusion is not as dire as it sounds. Even if it is imposed, the late deposit penalty can be abated or removed in many cases.
Congress provided that the penalty does not apply if the employer can establish reasonable cause for the failure. There are numerous reasons that can establish reasonable cause. This might even include reduced business operations due to the covid situation, for example. Taxpayers who are assessed late deposit penalties should consider submitting a penalty abatement request or claim.
If the employer does not have similar penalties in the prior three years, the IRS will likely abate the penalties under its first-time abate policy. This should also be raised as an issue in the penalty abatement letter or claim.
If these options are not available or fail, the employer may also be able to rely on IRS Notice 2020-22. IRS Notice 2020-22 provides relief for late deposit penalties that were attributable due to the employer believing that payroll tax credits were going to be available. This includes the employee retention credits and family medical leave credits under the Families First Act and the CARES Act. Many employers may find that they did not take advantage of these credits and/or did not calculate the full allowable amount of these credits. This could provide a remedy to help avoid the late deposit penalty.