It is widely known (hopefully not from experience) that failure to pay taxes can have severe consequences. Payroll taxes are no different. In fact, collecting and remitting payroll taxes is an area riddled with misrepresentation and even fraud. The IRS reported twenty-three cases in 2023 and fifteen cases so far this year of business owners and officers being prosecuted for willful nonpayment of payroll taxes. The consequences range from penalties and fines to consecutive sentences of jail time. All the reported companies had corporate protections, so how is the IRS able to pierce the veil and prosecute officers, shareholders and even managers?
What is The Corporate Veil?
The Corporate Veil is not a physical protection, but rather a phrase to represent the idea that the owner or shareholder of a company is not legally liable for the actions of the company. It alludes to protection for owners, shareholders and partners’ personal assets should the corporation find itself in debt or suit.
“Shareholders may hide behind the corporate veil, assured that their liability does not extend beyond the value of their shares.” –cambridge.org
For real protection behind the corporate veil, the corporation must use a separate bank account, file separate tax returns and use the corporate assets for business purposes only. This is where the guilty parties in the IRS cases went wrong. They used trust fund taxes collected to pay other creditors instead of the IRS, or worse, for their personal spending.
What is a trust fund tax?
Tax amounts that are collected and held in an account and then paid to the tax agency monthly or semi-weekly are called trust fund taxes. Payroll taxes such as federal and state income taxes, Social Security taxes, Medicare, unemployment and state sales taxes are the most common. It is the responsibility of company officers and managers to collect payroll taxes from their employees, hold them in an account, then remit the funds to the relevant agencies on time.
These funds are taken directly from employee income and should never be looked at as an asset belonging to the corporation. They are not reserves available to pay vendors or debts. And the funds are absolutely not for personal use by owners to buy boats and vacation homes.
Who is liable to ensure payment of Payroll Taxes?
As with most business law, the owner, partner and shareholders hold the ultimate responsibility for the decisions and actions of the company. But when we talk specifically about collecting, accounting for and remitting payroll taxes, the rules are expanded and specific as to who can be held responsible. Notably, the willful nonpayment of payroll taxes looks all the way to the manager or person who has authority to pay, or direct someone to pay.
- An officer or an employee of a corporation.
- A member or employee of a limited liability company (LLC).
- A corporate director or shareholder.
- A member of a board of trustees or directors of a nonprofit organization.
- Another person with authority and control over funds to direct their disbursement or
- Another corporation or third-party payer.
In order for the willful portion of the willful nonpayment ruling to be true, the person must have been, or should have been, aware of the outstanding taxes and either intentionally disregarded the law or was plainly indifferent to its requirements (no evil intent or bad motive is required). This means that a statement of not knowing is not a defense. An officer or manager claiming they did not know they had to remit the taxes is not a valid claim as the law says they should know, and therefore could be held liable.
What can happen if Payroll Taxes are not paid?
Failure to pay taxes on time carries risk of financial penalties plus interest on that penalty. This includes reporting incorrect estimates that later have to be corrected. If this occurs, you will receive a formal Notice from the IRS. If the failure is regarding payroll taxes, the Failure to Deposit Penalty notice will state how many days you are late, the amount of the penalty and the due date for paying the penalty. Interest charges can be assessed on the penalty.
An oversight in estimates or one-off delayed deposit to the IRS can usually be cleared up fairly easily by paying the penalty and correcting any internal processes that caused the delay. However, business o
wners sometimes find themselves short on cash and looking for creative ways to pay creditors and vendors. Trust funds can be a tempting short-term fix, but this should never be the go-to solvent. Not only will penalties begin to add up on day one of being late, but you have now crossed over into the misappropriation of tax trust funds. And eventually, the IRS will catch up to you and your illegal choices.
Repeated misappropriation actions will definitely result in hefty penalties and interest but could also result in prosecution and jail time sentences. In January 2023, a Nevada pediatric dentist pleaded guilty to failing to deposit payroll tax funds to the tune of $289,654.63 in IRS losses. He faced up to five years in federal prison, monitored release and financial penalties. Florida business owner Timothy Meade was sentenced to 30 months in prison in March 2024 for failing to deposit withheld payroll taxes to the tune of $971,130. Unfortunately, even payroll companies have been prosecuted for fraudulent activity, breaking not only federal laws, but the trust of countless clients and employees.
What can I do to protect myself?
The short answer is to make certain you pay taxes to the appropriate agencies, on time!
It is understandably alarming to learn that the protections you thought you had by filing an LLC or incorporating are not sufficient armor when it comes to collecting taxes. The veil will offer protections against other liabilities as an owner or officers, but when tasked with the responsibility to collect, account for and remit payroll taxes on behalf of your employees, the only protection is to operate with the utmost integrity.
You should implement processes that provide oversight and audit processes to ensure you as the business owner are not knowingly, or unknowingly, failing to remit payroll taxes.
- Ensure business accounts are used for business purposes only.
- Have checks and balances in place – don’t allow one person to control the entire process.
- Ensure IRS notices are delivered to you.
- Ensure you have access to online IRS and state accounts to periodically audit.
- Work with a payroll expert with the highest integrity, like Valor Payroll Solutions.
- Have an audit process with your payroll provider to ensure compliance.
Nothing replaces a stringent process for collecting, accounting for and depositing payroll taxes. Even the corporate veil will not offer protection from fraudulent activity or nonpayment.
Valor Payroll Solutions is a resourceful team of experts you can trust to follow through on all your payroll responsibilities, including remitting taxes timely and accurately. We are dedicated to being your partners in growth, compliance, and long-term success through payroll processing excellence. Need help assessing your current payroll tax collection and deposit processes? Reach out today to take advantage of our free consultation!
