The Internal Revenue Service (IRS) never forgets unpaid payroll taxes and relentlessly pursues what’s owed until it’s resolved. Unpaid payroll taxes are a serious legal issue that can trigger penalties, personal liability, and asset seizures for the business owner involved. Until the full amount is paid or a formal agreement is reached, the debt will continue to grow with interest and penalties.
So, to pay back payroll taxes, you can settle the entire amount at once or negotiate a structured payment plan with the IRS. You can also apply for relief through an Offer in Compromise or any other IRS hardship program, depending on your financial situation.
Not sure how to pay back payroll taxes? Schedule a free consultation with an qualified tax attorney at Victory Tax Lawyers. We are experts in helping businesses resolve their tax debt, avoid costly penalties, and get back on track with the IRS.
This guide explores exactly what payroll taxes are, why they go unpaid, what to do if you’re already behind, and how to protect yourself and your business from future back payroll taxes.
What Are Payroll Taxes?
Payroll taxes, also known as employment taxes, are a combination of taxes withheld from an employee’s paid wages and salaries, as well as the taxes paid directly by the employer. These include federal income tax, Federal Insurance Contributions Act (FICA) taxes such as Social Security and Medicare, as well as the Federal Unemployment Tax Act (FUTA) tax.
In some states, there are additional state income taxes and unemployment taxes layered on top of the federal obligations. You should also know that payroll taxes are not optional. Instead, they are mandated under federal law.
How Do Payroll Taxes Work?
When a business processes payroll, it is required to withhold the employee’s share of taxes and hand them over to the IRS, along with the employer’s share of tax. The employee’s payroll tax portion consists of federal income tax withholding, which is entirely dependent on the W-4 form they submit. Also included in an employee’s portion is their share of Social Security and Medicare taxes.
Social Security tax is often 6.2% of wages up to the federal wage base limit, and Medicare tax is over 1.45% of all wages, with an additional Medicare tax of 0.9% for high-income employees who earn more than $200,000 annually. These withheld amounts are not considered business funds. Instead, they are trust fund taxes, which implies that the business is temporarily holding them on behalf of the government.
In addition to the amounts withheld from employees by the employer, the employer in question is also responsible for matching the Social Security and Medicare contributions from the business’s funds. This implies that the employer pays an additional 6.2% and 1.45%, respectively, for each employee. The employee is also mandated to comply with the Federal Unemployment Tax Act (FUTA), which imposes a 6% tax on the first $ 7,000 earned by the employee. In cases where employers qualify for a credit of up to 5.4% when they pay state unemployment taxes on time, the FUTA tax rate can be reduced to 0.6%.
Keep in mind that the Federal Unemployment Tax Act (FUTA) tax is not withheld from the employee’s wages. Employers must report these taxes quarterly using Form 940 and submit tax payments in line with IRS deadlines.
Why Payroll Taxes Go Unpaid
Payroll taxes often go unpaid due to cash flow issues and administrative oversights, which may cause employers to skip filing or fail to withhold and remit the correct tax amount to the IRS. Not minding what your reason may be, you should understand that the agency generally takes unpaid payroll taxes as a serious violation, and they take quick action.
Cash Flow Problem
A frequent reason why payroll taxes go unpaid is due to a shortage of cash. In cases where business owners are on a tight budget, they may prioritize rent and vendor payments over funds for employment taxes. Since payroll tax withholding is taken from employees’ wages but not yet paid to the IRS, the business may be tempted to use the tax funds to cover urgent operational costs. This is usually done with the hope that they’ll replace the funds before the deadline for deposit to the IRS.
However, the replacement is often not completed in many cases. Once the tax deposit deadline passes and the money is yet to be recovered, the business becomes officially behind in payroll taxes. From that point, what started as a temporary cash fix can turn into a major compliance violation. The IRS may believe that it’s a misuse of trust fund taxes, which may lead to penalties, interest and even personal liability under the Trust Fund Recovery Penalty (TFRP)
Administrative Errors
Costly administrative errors are internal slips that may occur due to missing systems, inexperienced staff, or poor communication between different departments. The error may also appear when businesses file the wrong forms or fail to file them altogether.
Forgetting to file Form 941, which is the employee’s quarterly federal tax return, sending the form after the stipulated deadline, or submitting it with incorrect figures can all result in penalties, interest, and unwanted IRS attention. The same applies to Form 940 for Federal Unemployment Tax Act (FUTA) taxes or corresponding state employment tax filings.
Missed Deadlines and Deposit Schedule Errors
There are different timing requirements for depositing payroll tax to the IRS, and these timings depend on the business’s filing history, the particular return on which the taxes are reported, and many other factors. Due to this effect, some businesses are required to make deposits semi-weekly, while others may need to follow a monthly schedule. You should also be aware that as a business’s payroll increases, its required deposit frequency tends to change.
In a situation where a business misses its actual timing for payroll tax deposit, the IRS applies penalties even if you’re just a few days late, and interest starts accumulating immediately.
Misclassification of Workers
Employers may try to avoid payroll tax obligations by issuing 1099s instead of W-2s to classify certain workers as independent contractors. This way, they may not withhold Social Security, Medicare, or federal income taxes.
If the IRS investigates and finally determines that those workers should have been classified as employees, the employer becomes responsible for all back payroll taxes, penalties, and interest. Even if the misclassification wasn’t intentional, the consequences are the same. Additionally, if it was done to cut costs knowingly, it could also make them prone to audits, litigation, or criminal penalties.
Business Transitions or Closures
When a business shuts down or changes ownership, its payroll tax responsibilities don’t go away. If returns aren’t properly filed or taxes aren’t paid before dissolution, the IRS may pursue former owners, officers, or anyone with financial control for the unpaid balances.
What to Do if You Owe Payroll Taxes
If you owe payroll taxes, don’t ignore the issue, as doing so will only make it worse. In cases like back payroll taxes, the IRS is relentless, and what started as a small delinquency can result in large tax debts with penalties, growing interest and potential legal exposure. So, you should contact a tax attorney and file any missing or corrected returns as soon as possible.
Contact a Tax Attorney
If you owe payroll taxes, this is when you should hire a tax attorney who has experience in handling payroll tax issues. These cases are not like the typical tax problem. Payroll taxes involve trust fund taxes, which implies that the IRS may hold business owners and officers personally liable for unpaid amounts through the Trust Fund Recovery Penalty (TFRP).
Working with a qualified tax attorney provides you with legal protection and a strategic approach to managing your tax affairs. To get the best possible outcome for resolving your unpaid payroll taxes, contact a tax professional who can help you:
- Evaluate your exposure to personal liability, especially if you’re a responsible party under TFRP standards.
- Negotiate directly with the IRS to minimize aggressive enforcement and propose manageable solutions.
- Request penalty abatement or relief from excessive interest when justified.
- Structure a defense or resolution if you’re facing potential criminal charges or audit proceedings related to payroll tax fraud.
Determine How Much You Owe
You need to know precisely how much you owe in back taxes, as well as the associated penalties and interest. Note that the IRS often sends notices if you have unpaid balances. For instance, CP161 is sent to inform you of a balance due for unpaid payroll taxes. Another notice, CP276B, warns of a possible failure-to-deposit penalty for missing deposits. On the other hand, IRS Letter 1153 notifies you of a proposed Trust Fund Recovery Penalty assessment. Gather all recent IRS letters and review them accordingly.
You can also reconcile your records by reviewing the Form 941 and Form 940 you may have filed for the periods in question. If returns weren’t filed, the IRS may have filed a substitute return estimating what you owe. Go ahead and log in to your account on the IRS portal to see the total taxes you owe.
Additionally, you or your representative can choose to contact the IRS or request an account transcript to view all assessed balances. The goal is to have a clear figure of the tax, penalties, and interest outstanding, as it will inform your next steps and any negotiation with the IRS.
File Missing or Corrected Returns
Another step you should take when you owe back payroll taxes is to file all missing or corrected returns. The IRS requires all tax filings to be up to date before they consider any form of resolution, including an Installment Agreement, an Offer in Compromise, or penalty relief. Filing the returns will also prevent the failure-to-file penalty from accruing. The failure-to-file penalty is 5% of the tax per month and it’s ten times higher than the 0.5% per month penalty for failing to pay.
To get started with the returns filing, you should begin with filing any delinquent Form 941, which is the employer’s quarterly federal tax return. The form usually covers the report of income taxes withheld from employee wages as well as FICA taxes.
Also, if you’re in a situation where you discover that the payroll tax amount that you initially reported was incorrect as a result of either miscalculations or bookkeeping errors, you must file Form 941-X to correct those errors.
Tips on How to Pay Back Payroll Taxes
To pay back payroll taxes, you must either pay the balance in full or set up an arrangement with the IRS based on your financial ability. The IRS offers several alternative relief options to resolve unpaid payroll tax debt if you can’t resolve the debt in full, including Installment Agreements, Offers in Compromise (OIC), or a temporary delay in collection if you can prove financial hardship. You may be able to qualify for any of these tax relief options when you meet the requirements for any of them.
Full Payment
When you pay the entire balance of your employment taxes, you automatically stop penalties and interest from accumulating, and you avoid further collection actions like liens or levies. Full payment demonstrates good faith and quickly removes the IRS from your business affairs.
To make full payments, you can do so through the Electronic Federal Tax Payment System (EFTPS), a secure, IRS-managed platform that allows you to pay federal taxes directly from your bank account.
Alternatively, you can decide to send a check or money order by mail, although electronic payments are faster and provide confirmation. You should also contact the IRS or access your online IRS account to review your tax transcripts and exact balance before you go ahead with the payments.
Installment Agreements
If paying in full may not be possible as a result of your financial situation, the IRS offers an Installment Agreement, which allows you to pay your payroll tax debt over time. There are two main types: short-term plans, which are meant to be completed within 180 days or less, and long-term agreements, which may span several years.
To apply for a long-term installment agreement, your payroll tax debt must be $25,000 or less, and you must be current on all required filings. Once this is settled, request an Installment Agreement online, by mail, or by speaking directly with an IRS representative. When proposing a payment plan, you’ll need to provide details about your income, expenses, assets, and liabilities so the IRS can determine an appropriate monthly payment.
A very important advantage of installment agreements is that they prevent enforced collection actions, such as levies and garnishments, as long as you stay compliant with the plan. However, you should also be aware that interest and penalties will continue to accrue until the full balance is paid, and defaulting on the plan can restart aggressive collection actions.
Offer in Compromise (OIC)
An Offer in Compromise (OIC) is a program that allows you to settle your payroll tax debt for less than the full amount owed. However, this program is only available to businesses that meet strict eligibility criteria. The IRS will only accept an OIC if it believes you genuinely cannot pay the full amount through a lump sum or over time through an installment agreement.
To get approved for an Offer in Compromise, you must be up to date on all tax filings and not currently involved in an open bankruptcy proceeding. The IRS will go ahead to evaluate your reasonable collection potential (RCP), which is an estimate of your ability to pay based on income, expenses, and equity in assets.
Additionally, the OIC application process requires Form 656 along with Form 433-B. You’ll also need to include a non-refundable application fee of $205 as well as a non-refundable initial payment unless you qualify for a low-income waiver.
Temporary Delay in Collection
The IRS may grant a temporary delay in collection by classifying your account as Currently Not Collectible (CNC) if your business is under severe financial stress and can’t afford to pay anything toward payroll tax debt. The CNC status halts all collection actions, including bank levies and liens. However, it does not eliminate your debt.
You’ll need to submit financial documents proving that your income barely covers basic operational expenses to qualify for this tax relief option. The IRS will periodically review your financial status, and collection may resume if your situation improves.
What Happens if You Don’t Pay Payroll Taxes?
If you don’t pay payroll taxes, you should be ready to face serious consequences from the IRS, including penalties, interest, tax liens, levies on your accounts, wage garnishments, audits, and even criminal charges. The IRS may also hold business owners and responsible individuals personally liable through the Trust Fund Recovery Penalty, which can wipe out your assets.
Hefty Financial Penalties and Interest
The IRS imposes escalating penalties when you fail to timely deposit or file payroll taxes. They may also include a separate failure-to-file penalty of 5% per month. Beyond the penalties, interest also accrues daily, which means that your debt tends to double quickly.
Trust Fund Recovery Penalty (TFRP)
As stated in Section 6672(a) of the Internal Revenue Code, the IRS can hold individuals, including business owners, officers, or anyone responsible for payroll, personally liable for 100% of the unpaid taxes withheld from employees. This Trust Fund Recovery Penalty means the IRS can pursue your assets, and it is neither dischargeable in bankruptcy nor tax-deductible.
Tax Liens and Levies
Unpaid payroll taxes also trigger tax liens, which are legal claims against your business assets. When this collection action kicks off, it damages your credit, limits your ability to sell property, and shows up in public records.
If the debt continues unpaid after a notice of intent to levy is issued, the IRS has the right to seize your bank accounts, accounts receivable, or business property to cover the tax liability. Once the levy kicks off, it both interrupts your business operations and can cause lasting damage to your business’s financial health.
Difficulty Obtaining Credit
Businesses with outstanding payroll tax debt and active liens often lose access to financing. Lenders often don’t accept this, and your business credit rating may plummet. As a result, you may be unable to qualify for business loans, lines of credit, or even future funding opportunities.
Criminal Charges
In extreme cases where the IRS believes non-payment was willful or tied to fraud or tax evasion, the agency may pursue criminal charges. As stated in U.S. Code Title 26 §7202, if the IRS determines that a business owner or responsible party willfully failed to pay employment taxes, felony charges may be filed. These offenses carry hefty fines and potential prison time.
Business Disruption and Forced Closure
When tax debt piles up, and collections action still begins, business operations can be entirely crippled. Seized funds, frozen accounts, credit denial, and constant IRS involvement can bring business activity to a standstill. Many companies tend to shut down at this point because unpaid payroll taxes may have destroyed their operational foundation.
Intense Scrutiny and IRS Audits
Owing payroll taxes often triggers further audits and investigations. Once flagged, your business may face years of additional scrutiny from both the IRS and state tax authorities. This includes in-depth reviews of your finances, payroll processes, and records, which often leads to more stress, time loss, and legal vulnerability.
Amidst all these consequences, you should remember that if you’re facing payroll tax problems, you do not have to handle the issue alone. Schedule a free consultation with a tax attorney from Victory Tax Lawyers and see how we can help business owners like you understand your legal exposure, communicate with the IRS, and resolve tax debt before it gets out of hand.
What if I Can’t Afford to Pay Anything Right Now?
You should file all your payroll tax returns on time, even if you can’t afford to pay anything toward your payroll taxes right now. Don’t make the mistake of thinking that delaying your filing will buy you more time.
Failure to file triggers a higher penalty than failing to pay. You should also know that filing your returns when due shows the IRS that you’re not trying to hide or evade your obligations. It also protects you from additional legal issues, keeps you in compliance on paper, and increases your chances of qualification if you later need to negotiate or apply for relief.
Additionally, you should try to pay whatever amount you can afford to pay. Partial payments are better than no payments at all because they help reduce the principal balance the IRS uses to calculate penalties and interest. More importantly, paying what you have signals to the agency that you want to resolve the debt and are not deliberately neglecting your responsibilities.
Lastly, you should contact the IRS and speak to a qualified tax professional as soon as possible. Waiting for the IRS to initiate contact often results in more aggressive enforcement actions, such as liens, levies, or wage garnishments.
A tax attorney can also help you request Currently Not Collectible status, which temporarily halts IRS collection efforts if your financial records show that you’re unable to pay anything without risking your basic living or business operations.
How to Prevent Future Payroll Tax Problems
Once you’ve gone through the stress associated with resolving back payroll taxes, the last thing you want is a repeat. The best way to prevent future payroll tax problems is to stay organized by implementing clear accounting systems, using reliable payroll services, and keeping up with changing tax laws to reduce the risk of costly mistakes and penalties.
Implement Better Accounting Practices
A reliable accounting system is needed to prevent future payroll tax problems. You must keep accurate and organized records of employee wages, payroll tax withholdings, and payment schedules. Also, try your best to separate payroll tax funds from general operating accounts to avoid accidentally spending money owed to the IRS. Regularly reconcile payroll records with tax deposits to catch discrepancies early. Having clear documentation also makes it easier to respond to any IRS inquiries or audits.
Hire a Payroll Service Provider
Outsourcing payroll to a trusted third-party provider can reduce the risk of errors. Payroll service companies specialize in accurately calculating, filing, and depositing employment taxes promptly.
Payroll service providers tend to keep up with due dates, deposit schedules, and tax form requirements, which minimizes your exposure to penalties for late or inaccurate filings. For most employers, mostly small business owners without a dedicated accounting team, hiring a payroll provider is an investment that saves time and protects against costly mistakes related to tax payments.
Stay Informed About Tax Law Changes
Tax laws and payroll regulations don’t often remain the same year after year, and staying unaware of these changes can put your business at risk. As a business owner, it’s your responsibility to keep up with these changes, or at the very least, make sure your accountant or payroll provider does.
Additionally, subscribing to IRS updates, reading trusted legal or accounting publications, or regularly consulting a tax professional are all practical ways to stay informed. When you’re aware of your responsibilities under current law, it becomes very much easier to stay compliant and avoid falling behind on your payroll tax obligations.
Worried About Payroll Taxes?
The IRS takes unpaid payroll taxes seriously, and the longer you wait, the more complicated and expensive your situation becomes. Aside from owing the IRS, these issues can also damage your credit, disrupt operations, and expose you to audits or criminal investigations. That’s why it’s never a good idea to ignore payroll tax debt or delay action.
Also worthy of note is that you are not left without options, even if you can’t afford to pay your payroll tax balance right now. With the help of a qualified tax professional to guide you through the process, you may be able to qualify for alternative payroll tax relief options like an Installment Agreement, Offer in Compromise, or Currently Not Collectible status.
Overwhelmed by payroll tax liabilities? You don’t have to handle your situation yourself. Regardless of whether you need to review your tax debt, file missing returns, negotiate a payment plan, or defend against enforcement actions, Victory Tax Lawyers offer the legal support and representation you require. Schedule a free consultation now with the best tax attorneys in California.
Frequently Asked Questions
Can Payroll Tax Debt Be Discharged in Bankruptcy?
No, payroll tax debt cannot be discharged through bankruptcy. The IRS treats them as a priority debt, and responsible parties can still be held personally liable even after bankruptcy.
How Long Does the IRS Have to Collect Payroll Tax Debt?
The IRS generally has 10 years from the date the payroll tax was assessed to collect payroll tax debt. This Collection Statute Expiration Date (CSED) can only be paused or extended in certain situations, such as when you file an Offer in Compromise or as part of an Installment Agreement.
What Is the Trust Fund Recovery Penalty?
The Trust Fund Recovery Penalty (TFRP) allows the IRS to hold individuals personally liable for unpaid payroll taxes withheld from employee wages. This includes Social Security, Medicare, and Federal income taxes. Business owners, officers, or anyone with financial authority who willfully fails to deposit these taxes can be targeted.
How Many Years Can the IRS Go Back for Payroll Taxes?
The IRS can audit payroll tax returns within three years of the filing date. However, if a return was never filed or if there is evidence of fraud, there is no time limit, as they can go back as far as necessary.
Can Payroll Taxes Be Forgiven?
Payroll tax debt is rarely forgiven, especially the portion withheld from employee wages. While you may qualify for programs like an Offer in Compromise, full forgiveness is rare and only granted under very specific, strict criteria.
What Happens if I Ignore an IRS Payroll Tax Notice?
If you ignore an IRS payroll tax notice, the IRS can quickly escalate to wage garnishments, bank levies, and even personal liability through the Trust Fund Recovery Penalty. So, it’s of utmost importance that you respond promptly or get legal help from a tax professional immediately.
