If you own or run a business, there are certain things you need to know about. Two of those things just happen to be related to taxes, and they both happen to get people in scolding hot water with the IRS and their state if they screw around. I’m talking about payroll and sales taxes. The process is essentially the same for both: the business holds onto the taxes for the respective governing agencies until the time comes to report and remit them. Plain and simple, right? Wrong! And when it goes bad, the consequences are dire for the person or people responsible.
Generally, when talking about an incorporated entity (corporation, LLC, LLP, LLLP, PA, etc) there are certain inherent protections from personal responsibility–think of the “corporate veil”. If you are acting on behalf of the business, and within that business’s scope of operation, you can be reasonably assured that your personal assets will be protected in case of a lawsuit, bankruptcy, or other legal actions. When it comes to these two cases, however, that protection goes out the window. Seeing as how the taxes previously mentioned belong to another, you as the representative of the company entrusted with holding these funds, can be subject to civil penalties should they not be remitted to the proper authorities when they are required to be. First, let’s look at what these taxes actually are:
Payroll taxes are what are known as trust fund taxes. A trust fund tax is money withheld from an employee’s wages (income tax, social security, and Medicare taxes) by an employer and held in trust until paid to the Department of the Treasury on behalf of the employee. When an employee gets paid, the taxes that get withheld from their checks do not magically end up at the IRS, they have to be transmitted periodically (depending on each employer’s liability history). But until then, the employer holds onto the funds, thus earning the title of “trust fund taxes”. Essentially, the employer is acting as the middle-man or middle-woman ( for all the ladies out there ) between the individuals and the Treasury Department.
Sales taxes are similar to payroll taxes, in that the a company that collects this tax, holds onto the collections until it is time to transmit the funds to the state collection agency (again, depending on the company’s liability history). When a company makes a sale of taxable goods or services, they are responsible to add a sales tax to the purchase price, and this additional amount gets held until the time comes to files a Sales Tax Return. Additionally, unless the business has an exemption, all purchases must have included sales tax, and if they weren’t, or if the sales tax charged wasn’t as high as the local level, the difference is supposed to be made up when filing the Sales Tax Return.
Now that the basic understanding is laid out, we can move forward and examine why the penalties for not submitting these funds are so steep and reach the personal level. As I mentioned earlier, the monies are already supplied to the company by either the employee or customer. When you write a paycheck, you are paying an amount less certain taxes that you hold back, and when you make a sale you collect the sales price plus the additional tax. In both cases, the funds are essentially given to the company by the other party so the company already has possession. When that company fails to complete its duty and deliver the funds to the respective government body, it is considered fraud since:
The money belongs to someone else, and
The money is already collected so there is no reason the company should not have it available to submit
The person or persons responsible for collecting and remitting the funds should know full well how the process works, and anyone who willfully fails to comply with law will be held personally responsible for paying the taxes should be business be unable to do so. The willfulness factor is the key, because sometimes a person simply isn’t fully aware that outstanding tax liabilities exist, such as in the case of a new bookkeeper just taking over the duties, or the business owner who gives full autonomy to the controller, payroll specialist, or some other person within the company. The clearest case of willful failure to comply with payroll tax deposit laws would look something like this:
You are the sole shareholder and officer of XYZ company, handling the payroll for yourself and one other employee. Payday is every Friday, and you are a monthly depositor, meaning that you must deposit the payroll taxes (Social Security, Medicare, and federal withholding) by the 15th of the following month. Business is slow, so you continue to pay your bills, but when it comes time to make your tax deposits, there isn’t enough money so you just let it go, but continue to pay your other bills regularly and timely all the while knowing that the payroll taxes were due.
That’s it, plain and simple. You knew that you had a liability to make the tax deposits, but you instead decided to use the money to pay your operating expenses. That is willful failure to comply at its most basic level.
Now, for sales tax, there are several ways to fall into the personal penalty, and each state has its own guidelines and punishments, but examples of situations that could get you in trouble with your state taxing authority may consist of:
- Failure to file a sales tax return
- Failure to report taxable transactions
- Failure to remit sales taxes
- Failure to report purchases in which the company was not charged or charged less than the local sales tax rate
Again, willfulness plays a big part in being charged with a civil offense, but the general assumption is that a business owner did his or her due diligence in researching what is required of them, and is knowledgeable of the rules and requirement of running that particular business.
The bottom line is, that when dealing with someone else’s money you need to play by the rules or else you will lose any protections normally afforded to you by choosing a registered and incorporated business structure. Not only can your business be shut down, but you may be held personally responsible for the taxes and face civil penalties as well.