By Mark E. Battersby

The Government Accountability Office reported that last year 1.6 million businesses owed more than $58 billion in unpaid payroll taxes.  

After all, what hope has a confused chiropractor faced with withholding on so-called “supplemental wages” paid by his or her practice?” What about withholding payroll taxes when a worker’s status changes from “independent contractor” to employee? More importantly, how can you hope to avoid or minimize those almost inevitable payroll tax penalties?

Employer-paid taxes

You as an employer are required to withhold and pay employment taxes but, what are they?

• Medicare and Social Security (FICA): You pay half, and withhold the other half from the employee’s paycheck.

• Federal unemployment tax (FUTA): You must pay federal unemployment tax on the first $7,000 earned by each employee.

• State unemployment tax: Like federal unemployment taxes, you, not employees, pay. Rates are generally based on a practice’s location, size, and number of employees.

• Supplemental wages: Such as commissions, draws, signing bonuses, severance pay, annual payments of vacation and sick leave, paid at fixed intervals, sick pay at a different rate than regular pay, and lump-sum payments of accumulated annual leave.

New rules for withholding on supplemental wages

Before the IRS’s new guidelines, employers electing to use the flat rate of withholding for supplemental wage payments withheld at the third lowest tax rate for single filers, i.e., 25 percent. That rate applied to the entire payment regardless of amount.

However, if a supplemental wage payment, when added to all other supplemental wage payments previously made by you during the calendar year exceeds $1 million, the excess is subject to mandatory withholding at the highest income tax rate effective for that year, i.e. 35 percent.

Beware

According to recent reports, approximately 30 percent of IRS audits focus on the employee vs. independent contractor issue. The IRS may further review a personal income tax return, which over a period of several years has included only Form 1099 source income.

Although reclassification of a worker most often occurs after an audit, the worker or you can ask the IRS to determine whether the worker is an employee or a nonemployee for federal employment tax purposes. The tax laws provide a lower federal employment tax rates for prior years in which workers have been reclassified as employees.

The tax law prescribes reduced tax rates for misclassified workers in order to increase tax compliance. The law reduces your federal income tax withholding liability from the amount you are required to withhold to 1.5 percent of the employee’s wages for federal income tax withholding. The law also reduces your liability for the employee’s portion of FICA taxes to 20 percent of the normal amount.

According to the IRS, the reduced rates are only for prior years’ liabilities attributable to reclassified workers. If you fail to deduct and withhold employment taxes during the current calendar year because you thought the worker was an independent contractor and discovered such error during the year, you can remedy the withholding failure before the calendar year ends.

Employment tax adjustments

The IRS has issued regulations that modify the process for making interest-free adjustments for underpayments and overpayments of the Federal Insurance Contribution Act (FICA) and federal income tax withholding.

When you discover an employment tax return filed with less than the correct amount of employees or your portions of FICA or RRTA tax, you should adjust the resulting underpayment of tax by reporting the additional amount due on an adjusted return for the return period.

Unfortunately, the adjustment must be made by the due date of the return for the return period in which the error was discovered.

Naturally, the underpayment amount must be paid at the time of the adjustment, or interest will begin to accrue from that date. The

tax regulations do not, however, require you to repay or reimburse the employee.

On the other hand, the tax regulations also set out the procedure for filing a refund claim for an overpayment of FICA or RRTA tax. Naturally, you must certify that you have repaid or reimbursed the employee’s share of FICA or RRTA tax to the employee or have secured the written consent of the employee to allowance of the refund or credit.

Responsible parties

There are civil penalties for those who fail to make proper or timely payments and deposits. For any willful failure to withhold or pay employment taxes, penalties and criminal sanctions may apply.

Beware however, once the IRS has levied a payroll tax penalty, they can take action against the personal assets of any or all “responsible parties."

In other words, if unpaid trust fund recovery penalties — or the employment taxes themselves — cannot be immediately collected from the practice, the IRS can attempt to collect from a so-called “responsible person.”

A responsible person is a person or a group who has the duty to perform and the power to direct the collecting, accounting, and paying of trust fund taxes, such as:

• An officer or employee of a corporation;

• A member or employee of a partnership;

• A corporate director or shareholder;

• Another person with authority and control over funds to direct their disbursement; or

• Another corporation.

Reducing payroll tax penalties

Obviously, payroll tax penalties can be devastating. A payroll penalty usually hits practices and businesses that can least afford them, new businesses with weak cash flow, troubled practices, and those that have suffered a casualty.

Fortunately, there are steps you can do to reduce a payroll tax penalty.

The first thing to do is ask the IRS to abate (eliminate) the payroll tax penalty. This is a feasible strategy if the underpayment of the payroll tax deposit is the exception, not the rule.

Generally, the penalty is abated if a taxpayer:

• Provides proof of timely payment;

• Revised its Form 941, Schedule B, Report of tax liability for Semiweekly Schedule Depositors;

• Makes a deposit redesignation; or

• Has reasonable cause for abating his penalty.

A chiropractic practice with a good compliance history has “reasonable cause” for abating a penalty. A “good compliance history” means the practice has not been hit with a penalty for the three consecutive preceding years (up to 12 quarters for Form 941 filers). A taxpayer with a good compliance history does not need any additional explanation for requesting abatement of the tax deposit penalties.

Naturally, the IRS will still consider abatement of the penalties in situations where the practice’s compliance history is not totally clean. Other examples of what the IRS might consider “reasonable cause” include:

• The death or severe illness of the practice’s principal;

• The unavoidable absence of the principal;

• The destruction of the taxpayer’s place of business; and

• Civil disturbances impairing the practice’s ability to make deposits.

In the end

Payroll tax penalties can be avoided by making sure all employment taxes are collected, accounted for, and paid to the IRS when required. Reducing payroll tax penalties begins with asking the IRS to abate or eliminate the payroll tax penalty. This is feasible if the underpayment of the payroll tax deposit is the exception, not the rule.

Obviously, it also helps to understand the rules for withholding employment taxes on those so-called “supplemental wages,” as well as the basic rules for withholding payroll taxes — and paying over withheld amounts — on the wages of all employees in the chiropractic practice.

Mark E. Battersby is a tax and financial advisor, freelance writer, lecturer, and author with offices in suburban Philadelphia. He can be reached at 610-789-2480.

DISCLAIMER: The author is not engaged in rendering tax, legal or accounting advice. Please consult your professional advisor about issues related to your practice.