The Most Common IRS Tax Problem Vexing Small Business Owners

Small business owners often find themselves owing a ridiculous amount of money to the IRS. Most have some sort of tax mishap early in their careers involving owing a large tax bill they can’t write off.

How does it happen?

For most small businesses, taxes are a financial and administrative burden, so many fall into the estimated tax trap. Not that they don’t pay their taxes in their entirety, no. The businesses pay their taxes but don’t follow the IRS guidelines on how to pay them, and end up attracting:

• Tax debt
• Penalties
• Interest on penalties

Sometimes the tax bills accumulate to a level beyond the business owner’s ability to pay, resulting in the closure of so many small businesses. While all tax problems are a big issue, there are those that the IRS considers worse than others. 

Let’s examine some of the most egregious ones. 

#1. Unpaid Payroll Taxes

One of the most grievous tax mistakes that attract the harshest penalties is unpaid payroll taxes. When a small business collects payroll taxes from employees and fails to remit the funds to the IRS on time and in full, it gets vulnerable to harsh penalties and even possible jail time.

IRS is serious with payroll taxes because they make up to 31% of the tax the federal government collects. As businesses collect these taxes throughout the year, the law requires them to put the amount in a trust fund until it’s ready for the IRS on a quarterly, monthly, or biweekly basis.

Not all businesses try to be malicious by not remitting the payroll taxes they collect from their employees. Some usually try to keep their lights on, intending to refund the trust fund account before tax day.

However, sometimes, that’s easier said than done. Most businesses that take this move perhaps forget to pay the money back or fail to materialize their expected future gains. Before knowing, the organization falls several years behind and starts drowning in thousands of dollars of tax debt — or worse.

The IRS Then Come Collecting With A Vengeance

The IRS reviews the above scenario as stealing from two groups:

• The employee
• The government

Even if your business intends to pay back fully, the failure to properly collect and send payroll taxes to the IRS attract the following consequences once the tax day comes:

• A maximum jail term of five years plus a $250,000 fine
• Twice the gross gain or loss from the offense
• A levy on account receivables
• Garnishment of your bank account

The IRS can be aggressive in getting unpaid payroll taxes back. Interests and penalties continue to compound until you file and pay, which can put a small business out of business. 

#2. 941 Late Payment Penalty

Apart from the failure of payment, the IRS can also impose a penalty if your business makes payroll deposits late, popularly known as Late Payment Penalty. The IRS will impose a penalty if your business files Form 941 or 944 later after the tax day. The penalties increase the later you file these forms.

How you prioritize paying IRS can make or break you because the consequences of being delinquent on business payroll taxes can be a deadly mistake to your business finances.

The Consequences of Late Payment

The penalty for delinquent payroll taxes can equal the amount of the taxes you owe, which is called the 100% Payroll Penalty or Trust Fund Recovery Penalty. Despite your success level, this penalty can be devastating.

Other less severe consequences include:

• If you delay filing and paying the payroll tax deposit within one to five days, the IRS will impose a penalty of 2% of what you owe.
• A 6-15 days delay attracts a 5% penalty of what you owe.
• You’ll attract a 10% penalty plus interest if you deposit the payroll tax after 16 days.

IRS Section 6672(a) states that the blame for not paying business payroll taxes goes to every responsible person who willfully neglected to pay the payroll taxes, including accountants, bookkeepers, and anyone with check signing ability.

Even if your business had good reasons to delay the payroll tax deposit, the IRS would still impose the 100% fee penalty.

Resolving IRS Unpaid Payroll Taxes 

Resolving the problems arising from late payment of Business Payroll Taxes is difficult. However, in the 1990s, some provisions were added to the Taxpayer’s Bill of Rights to help startup businesses. The provisions include:

Appeal Payroll Taxes

Many small business owners are unaware that they have rights as taxpayers. The law gives you 60 days from when the IRS issued a warning to file an appeal. The appeal can buy you more time to settle the debts. However, an appeal isn’t a permanent solution.

You can use the extra time to consult with tax professionals or seek professional advice.

First-Time IRS Offender

In the Taxpayer’s Bill of Rights, there is a law that can help a growing small business. According to this law, the IRS can forgive the harsh penalties it imposes when a small business owner fails to deposit payroll taxes on time.

However, this only applies if you’re a first-time offender. The IRS can also reduce the penalties if you send the payments directly to the IRS instead of depositing them in the trust fund.

Paying Back Taxes

Appeals rarely work. The IRS may not forgive penalties and back tax amounts even if you’re a first-time offender. When this is the case, you should pay off the tax liability as soon as possible.

Failure to pay the full tax in time may accrue interest every month and can double or triple the back taxes due. If your business can pay off the full-back tax amount, you should act on it and pay it off.

#3. Misclassification of Workers

Classifying workers is a bit of work, but you should do it properly. Workers come in two classifications, including:

• Employees
• Independent Contractors

Most small business owners misclassify employees out of ignorance. However, some do it maliciously. 

Whatever the reason, the IRS will penalize you for misclassifying workers because of two reasons:

• Reducing tax revenue: Taxes from workers makes up a huge part of all collected task. When you misclassify employees as independent contractors, you help them avoid income tax, which lowers the tax revenue. 

• Disrupting tax collection process: A misclassified employee suffers from double taxes payment and enjoys fewer benefits like insurance. Also, Medicare payments and federal unemployment taxes have employer contributions, and misclassified employee has to cover it themselves if the employer tags them as independent contractors.

In other words, the IRS interprets the misclassification of workers as stealing from the government, which might attract some hefty punishment.

Penalties for Employee Misclassification

When the IRS thinks that your business has misclassified workers, it can impose the following penalties:

• $50 for every unfiled W-2 form
• 100% of the matching Federal Insurance Contribution Act (FICA) payment for Social Security and Medicare
• Additional 40% of the employee’s part in FICA
• Extra 1.5% of the misclassified salary and interest on the whole worker’s wages

If a sign of malicious classification arises during the investigation, the IRS might impose extra penalties, including:

• An additional 20% of all wages your business paid the misclassified employees
• Your business might start contributing 100% FICA contribution for both employer and employee on Medicare and Social Security
• A possible fine of $1000 for every misclassified employee
• A jail term of up to one year 

Form 22-8 can help you distinguish between independent contractors and employees.

#3. Overstating Deductions

Searching high and low for tax deductions can help your small business thrive. However, some companies go overboard and make them up or artificially enhance the existing ones to inflate deductions or expenses.

Falsely claiming deductions, expenses, or credits on a tax return is a serious offense. If the IRS catches a business claiming false deductions, the penalties include the following:

• 20% of the disallowed amount for filling wrong claims
• $5000 if the IRS determines you filled a frivolous tax return

You’ll be forced to pay back the taxes you owe, plus penalties and interest. Your business shouldn’t be greedy when it comes to the IRS.

#4. Mixing Business and Personal Expenses

For small business owners, it’s easy to get things mixed up, especially when you’re starting or are self-employed. It’s tempting for a business owner to use a credit card for all expenses. 

The mix-up can make it hard for the IRS to tell legitimate business expenses from personal ones resulting in errors when claiming deductions. Plus, your business would have problems if it’s ever audited.

You can only deduct business expenses from your income for tax purposes, and the only way to ensure that is to separate business and personal finances. You need a different bank account and credit card when spending for your company. 

If circumstances force you to use personal assets for the business, such as a car or home office, you should keep detailed records to support any deduction you take. You can’t deduct what you didn’t and can’t document.

Proper Planning and Understanding Can Help You Beat The IRS and Avoid Tax Problems

While taxes are a financial burden for most small businesses, you can take several tax measures to insure your business against IRS. Some of the solutions you can implement include:

Getting a Bookkeeper

While you might have a limited budget, you should assess if your business has the expertise to deal with employee payroll taxes. If you aren’t in a position to handle your taxes, hire someone else to manage your budgeting, expenses, and revenue documentation to ensure you’re on the safe side of IRS legislation.

With well-organized documents, you can determine the following: 

• The amount to spend on your estimated quarterly payment
• The amount to withhold from your employee’s paycheck
• The exact deductions you can receive when filling return

Putting a tax professional between you and the account will prepare your business for the tax day, making it harder to develop problems with IRS.

Reach Out to Businesses That Specialize in Tax Resolutions

You may need more than accountants or bookkeepers, especially if you are already in tax trouble. Your business should partner with tax professionals for tax solutions you can count on.

A tax professional will evaluate your situation and provide the answers you need to have peace of mind and security in understanding your options.