Avoid These Expensive Mistakes on Your Payroll Taxes

Issuing a paycheck is not as simple as writing, signing, and handing a check to an employee. The federal and state government expect employers to withhold certain taxes from an employee’s check and submit those taxes, along with employer’s payroll taxes, to the correct taxing authority by certain deadlines. Failing to report payroll properly and pay tax authorities could cause costly fines and penalties for employers.

However, is failing to report payroll or failing to pay payroll taxes the most expensive payroll mistake you can make? Both mistakes can be costly.

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In reality, there are several expensive mistakes you can make regarding your payroll taxes. It is typically in a business owner’s best interest to discuss payroll tax policies with a Maryland tax attorney to ensure the company does not make costly payroll tax mistakes, especially with new business owners.

Two Payroll Tax Mistakes You Need to Avoid

While there are several payroll mistakes you need to avoid as an employer, let’s look at two payroll mistakes that can be costly to make. 

1.  Misclassifying Your Employees

Improper classification of employees is typically the number one payroll mistake on anyone’s list of expensive payroll mistakes. The people who perform services for you will fall into one of two categories — employees or independent contractors. Even though two individuals may perform the same or similar services for your company, one person may be an employee while the other person may be an independent contractor. They may perform similar jobs, but their pay is handled differently. 

Your independent contractors are responsible for reporting their income directly to taxing authorities and paying any tax liability incurred related to that income. You may have to report payments made to an independent contractor once the payment exceeds a minimum amount for each year.

However, your business does not withhold taxes or pay employer payroll taxes for its independent contractors. Your business also is not required to offer independent contractors employee benefits, such as retirement benefits and health insurance. Many employers choose independent contractors over employees to reduce employment costs.

If you classify an employee incorrectly as an independent contractor, even by mistake, you could pay a significant amount of money to correct the error. Taxing authorities, including the IRS and the Comptroller of Maryland, will require you to pay all back payroll taxes for the employee you mistakenly classified as a contractor, in addition to penalties and accrued interest.

How can you avoid misclassification of employees?

Learn about employment taxes, including the various types of employment taxes, when to withhold employment taxes, and how to report and deposit employment taxes. Understand the differences between an employee and a contractor. Use the IRS 20 Factor Test to help determine whether you need to withhold and pay taxes for an employee based on the correct employee classification.

2.  Failing to Deposit or Submit Payroll Taxes

Withholding payroll taxes from employees is only one step in the process of accounting for and paying employment taxes. Since employers are acting as a fiduciary of the IRS with regard to collecting an employee’s tax withholdings and social security taxes, Congress enacted a law that provides for the Trust Fund Reco Penalty (TFRP).

The penalty is intended to encourage employers to exercise their duties and responsibilities as a “responsible” party for withholding, accounting, and paying trust fund taxes. Responsible parties could include officers, employees, shareholders, board members, payroll service providers, and other individuals who have authority and control over the trust funds. Trust fund taxes include income and employment taxes, including social security taxes. If a business willfully fails to collect or pay required taxes from an employee, the IRS may assess the TFRP jointly against the company and its officers, employees, shareholders, board members, payroll service providers, and other individuals who have authority and control over the trust funds.

“Willfully” is typically defined as knowing about the outstanding taxes, but failing to pay the taxes out of indifference or an intentional act. An employer’s actions could also be considered “willful” if the employer “should have been” aware of the outstanding taxes. Therefore, employers need to exercise due diligence when learning about their duties and obligations regarding employment taxes.

If the IRS imposes a trust fund penalty, it will send notice of the penalty to the employer and any parties deemed responsible for this failure. The penalty is typically equal to the amount of the delinquent withholding plus accrued interest. Employers and responsible parties have just 60 days to appeal a notice of penalty, or they could face levies and tax liens to collect unpaid employment taxes and penalties. 

Taxing authorities, including the IRS and the Comptroller of Maryland, will require you to pay all back payroll taxes for the employee you mistakenly classified as a contractor, in addition to penalties and accrued interest.

How can you avoid a Trust Fund Reco Penalty (TFRP)?

If your company has employees and you are unfamiliar with your responsibilities regarding employment taxes, contact a tax professional immediately. The best way to avoid payroll tax problems is to establish a payroll and accounting system that complies with all federal and state employment tax laws. A comprehensive payroll system, including a system of checks and balances, helps reduce the risk you will make a costly payroll mistake. If you do not understand payroll taxes, invest the time and money to hire someone that can set up the payroll system for your company, and teach you how to handle payroll and payroll tax deposits.

Contact a Maryland Tax Attorney for Help

It's easy to make mistakes with payroll taxes. The above examples are just two of the most common mistakes companies make when handling employee payroll and payroll taxes.

Other common payroll tax mistakes that could be costly for a company include:

  • Failing to pay the correct minimum wage for the position

  • Calculating overtime compensation incorrectly

  • Failing to pay the correct tax rates

  • Over-withholding or under-withholding employment taxes

  • Paying or processing payroll late

  • Failing to file the correct payroll tax returns

  • Failing to keep adequate books and records

  • Incorrectly reimbursing employee expenses

  • Waiting too long to seek legal advice and assistance 

A Maryland tax attorney can help you classify employees, set up a payroll system, ensure compliance with all federal and state tax codes, prepare tax returns, and respond to requests and notices from tax authorities.  The laws governing payroll taxes can be complicated. Get answers to your payroll questions and avoid payroll tax mistakes by seeking help from a Maryland tax attorney. Contact Thienel Law today. Maryland tax attorney Steve Thienel is dedicated to assisting clients in Maryland, Virginia, and throughout the DC Metro area.