Penalty for Not Witholding Federal Payroll Taxes

Employers are supposed to withhold federal income tax, Medicare tax and Social Security tax from employees' income. The Internal Revenue Service, which administrates federal payroll taxes, penalizes the employer if it fails to make the necessary withholding. Failure to withhold, report and pay federal payroll taxes can result in the employee not receiving a federal income tax refund or Social Security and Medicare benefits.

Under Withheld Taxes

Employers who do not withhold federal payroll taxes or collect less than they are supposed to are responsible for the underpayment. The employer must withhold the under withholding from future payments made to the employee on or prior to the last day of the tax year. The employer must withhold the tax in the current year so it shows on the employee's W-2.

Deposit Penalties

The Internal Revenue Service requires the employer to make federal payroll tax deposit via the method it mandates. Typically, employers make semiweekly or monthly deposits electronically, except if the employer is allowed to make the payment with its tax return. Failure to withhold payroll taxes can result in the employer incurring deposit penalties, which depend on the lateness of the deposit. For 2011, a 2 percent penalty of the tax due applies to deposits made one to five days in arrears, 5 percent for deposits made six to 15 days late, 10 percent for deposits made 16 or more days late, and 15 percent for amounts that remain unpaid after the IRS sends its first notice demanding payment.

Failure-to-File Penalties

The employer is required to file tax returns reporting its federal payroll tax liabilities. Most employers are required to file on a quarterly basis via Form 941; in some cases, the employer can file annually via Form 944. The employer incurs a failure-to-file penalty of 5 percent of the unpaid tax for each month or part of a month that the return is not filed; the maximum is 25 percent. In addition, a .5 percent failure-to-pay penalty is due for each month or part of a month that the return is filed late.

Considerations

The employer incurs interest on taxes not paid by the due date. For the first quarter of 2011, the interest rate for underpayment is 3 percent of the unpaid tax. Failure to withhold taxes can also lead to employer facing audits, and criminal investigation and prosecution.

References

• IRS.gov: Circular E
• IRS.gov: Interest Rates Remain the Same for the Second Quarter of 2010
• IRS.gov: IRS Warns Businesses, Individuals to Watch for Questionable Employment Tax Practices
• IRS.gov: Employer and Employee Responsibilities - Employment Tax Enforcement
• IRA.gov: Interest Rates Decrease for the First Quarter of 2011