Approximately 81% of the US Treasury's tax revenue comes from payroll taxes and federal withholding. Also called trust fund taxes, these employment taxes include Social Security, Medicare, and income tax withheld from employees' paychecks.
The US Congress gives the Internal Revenue Service (IRS) extensive collection powers over these taxes. In fact, the IRS takes these taxes more seriously than almost any other type of tax, and when I was working with the IRS, the agency made a strong push to collect unpaid payroll taxes over the last 10 years.
How far does Congress allow the IRS to go when collecting these taxes? The answer may surprise you — if these taxes are unpaid, the IRS can go after business owners, corporate officers, and anyone else responsible for withholding and paying these taxes. The agency can even hold lenders liable. Here's what you need to know.
Can the IRS go after employers to collect unpaid payroll taxes?
Yes. When employers withhold payroll taxes, they are required to deposit the taxes with the federal government monthly or semi-weekly, and they could be personally liable if they don't pay these taxes.
Usually, the owners of corporations and LLCs are not personally liable for business debts, but this rule does not apply to payroll taxes. The IRS can go after your personal assets to collect payroll taxes.
What about employees who are responsible parties for the unpaid payroll taxes?
Yes. The IRS can also go after employees who are responsible for paying these taxes. For example, if a bookkeeper doesn't deposit the payroll taxes, they could be held responsible.
Similarly, if an employer refuses to withhold payroll taxes from their employee's paycheck, the responsible employee for payroll can be held responsible for these taxes.
What about people who lend money to businesses for payroll?
Yes. I know it sounds bizarre, but even people who lend money to businesses for payroll can be held liable for these taxes.
IRS Rule on Payroll Tax Liability for Lenders
Title 26, United States Code, Section 3505 is a provision of the Internal Revenue Code (IRC) that allows the IRS to collect unpaid payroll taxes incurred by borrowers, directly from lenders.
Let’s take into consideration a father who helps his son start a landscaping business. The son hires employees, but during winter, the business's revenue drops so the son asks his father for a loan to cover wages. He says, "Dad, I just need enough money to pay my employees, but I'm not going to worry about the payroll taxes until later."
The father knows that the money is going to pay for net wages but not payroll taxes. In this case, the father could be held responsible for the unpaid payroll taxes.
Working Capital Loans and Payroll Tax Liability
The provisions of Section 3505(b) do not apply in the case of an ordinary working capital loan. Because these loans can be used for many purposes, the lender is not obligated to determine if the loan was used for wages or payroll taxes.
Lender Knowledge of Unpaid Payroll Taxes
Section 3505(b) applies when the person supplying the funds knows that the borrower is going to use the money to pay net wages but not payroll taxes. Net wages refer to the amount that the employee actually receives. They do not include payroll taxes and income tax withholding.
Let's return to the above example. Say the son tells his father, "Dad, I need a loan to cover payroll. I need money to pay my employees plus money to send to the IRS for payroll taxes." The father wants to help his son so he writes a check for that entire amount.
The son pays his employees, but he never pays the payroll tax. Instead, he uses the rest of the loan to buy office supplies for his landscaping business.
In this case, the father did not know the son wasn't going to pay his payroll taxes. By extension, he cannot be held liable under these rules.
IRS Determination of Lender Knowledge
How does the IRS determine if the lender has knowledge of the unpaid payroll taxes? Again, the IRS takes this issue very seriously, and they look fairly deeply at the facts and circumstances of each case.
Even a written contract cannot necessarily absolve the lender from liability. If the father and the son have a written contract saying the loan will be used to cover payroll and payroll taxes, but the father knows that the son really isn't going to pay the payroll taxes, the father can be held liable.
Need help with payroll tax problems?
If you have unpaid payroll tax problems, you need a professional to help you navigate these landmines. Contact me today — former IRS Senior Special Agent, Robert Nordlander CPA can help you resolve unpaid payroll tax problems.
If you are a CPA, you can earn two CPE credits in my course “Unpaid Payroll Taxes: The Quickest Way To Prison" available at CPA Crossings, LLC.