Payroll Tax Compliance
Payroll taxes are the most aggressively enforced federal tax obligation. The IRS treats unpaid employment taxes as theft from employees and the government, and personal liability can extend to anyone who controls business finances.
What are payroll taxes?
Payroll taxes (also called employment taxes) are taxes employers must withhold from employee wages and pay to the IRS. They fund Social Security, Medicare, and unemployment insurance.
Components of payroll taxes:
- Social Security tax — 12.4% total (6.2% employer, 6.2% employee) on wages up to the annual limit
- Medicare tax — 2.9% total (1.45% employer, 1.45% employee) on all wages, plus 0.9% additional Medicare tax on wages over $200,000
- Federal income tax withholding — Amount withheld based on employee's W-4 elections
- Federal Unemployment Tax (FUTA) — 6% on first $7,000 of wages per employee (employer-only, usually reduced to 0.6% by state credits)
Employers are responsible for withholding employee portions, matching employer portions, and remitting all amounts to the IRS on schedule.
Trust fund vs non-trust fund taxes
Employment taxes are divided into two categories with different consequences for non-payment:
Trust fund taxes (employee portions):
- Federal income tax withheld from employee wages
- Employee share of Social Security tax (6.2%)
- Employee share of Medicare tax (1.45%)
These amounts belong to the government from the moment they are withheld. The employer holds them "in trust." Failure to pay trust fund taxes can result in personal liability for responsible persons through the Trust Fund Recovery Penalty.
Non-trust fund taxes (employer portions):
- Employer share of Social Security tax (6.2%)
- Employer share of Medicare tax (1.45%)
- Federal Unemployment Tax (FUTA)
Non-trust fund taxes are business obligations. They remain with the business entity and generally do not create personal liability (except in cases of fraud or alter ego).
Why this distinction matters
If your business owes payroll taxes, the IRS first determines what portion is trust fund (employee withholding). That amount can be assessed against you personally if you are a responsible person. A compliance review analyzes your employment tax account to determine what's owed and what liability exposure exists.
Deposit requirements and schedules
Employers must deposit payroll taxes on a schedule determined by their total tax liability during a "lookback period" (the 12-month period ending June 30 of the prior year).
Monthly depositors
If lookback period liability was $50,000 or less: You are a monthly depositor.
- Employment taxes for wages paid during a month are due by the 15th of the following month
- Example: Wages paid in January → taxes due by February 15
New employers are monthly depositors until they have a lookback period to evaluate.
Semi-weekly depositors
If lookback period liability exceeded $50,000: You are a semi-weekly depositor.
- Wages paid Wednesday through Friday → taxes due by the following Wednesday
- Wages paid Saturday through Tuesday → taxes due by the following Friday
$100,000 Next-Day Rule: If you accumulate $100,000 or more in employment taxes on any day, you must deposit by the next business day. This also makes you a semi-weekly depositor for the rest of the calendar year and the following year.
Required forms and filings
In addition to making deposits, employers must file returns reporting employment taxes.
Form 941 — Quarterly employment tax
Form 941 (Employer's Quarterly Federal Tax Return) reports:
- Total wages paid during the quarter
- Federal income tax withheld
- Social Security and Medicare taxes (employer and employee shares)
- Deposits made during the quarter
- Balance due or overpayment
Due dates: April 30, July 31, October 31, January 31 (for Q1-Q4 respectively).
Form 940 — Annual unemployment tax
Form 940 (Employer's Annual Federal Unemployment Tax Return) reports FUTA tax for the year.
- Due by January 31 following the tax year
- If all FUTA tax was deposited when due, deadline extends to February 10
W-2 and W-3 filings
- Form W-2 — Wage and Tax Statement to each employee, due January 31
- Form W-3 — Transmittal of Wage and Tax Statements to SSA, due January 31
Penalties for non-compliance
Payroll tax penalties are severe and escalate quickly:
Failure to Deposit (FTD) Penalty:
- 2% penalty if deposit is 1-5 days late
- 5% penalty if deposit is 6-15 days late
- 10% penalty if deposit is more than 15 days late
- 15% penalty if deposit is not made within 10 days of first IRS notice
Failure to File Penalty: 5% of unpaid tax per month, up to 25%.
Trust Fund Recovery Penalty: 100% of unpaid trust fund taxes, assessed against responsible persons personally.
How the IRS enforces payroll tax compliance
The IRS prioritizes employment tax enforcement because these taxes are withheld from employees and belong to the government. Enforcement is faster and more aggressive than for income taxes.
- Automated notices begin shortly after missed deposits or unfiled returns
- Revenue officers are assigned to employment tax cases quickly
- Levies can be issued on business bank accounts without the extended notice period required for income tax levies
- Trust Fund Recovery Penalty investigations begin to identify personally liable individuals
- Criminal referrals are made in cases of willful failure to pay or fraud
Examples of payroll tax compliance issues
Example 1: Missed deposits, filed returns
Situation:
A business filed all Form 941s on time but made deposits late every quarter due to cash flow issues. The returns show taxes owed but deposits were made 30+ days after the due date.
Compliance determination:
Not compliant. Returns filed, but 10-15% FTD penalties assessed on each late deposit. If trust fund portions remain unpaid, responsible persons face TFRP investigation. The business has significant penalty exposure even though returns were filed.
Example 2: Deposits made, returns unfiled
Situation:
A business made all payroll tax deposits on time through their payroll service. However, Form 941 was never filed for three quarters because the business owner assumed the payroll service handled it.
Compliance determination:
Not compliant. Deposits are credited to the account, but the IRS has no return showing what the deposits are for. Failure to file penalties apply. The account cannot be reconciled until returns are filed matching the deposits.
Example 3: Payroll service fraud
Situation:
A business paid a payroll service to handle all employment taxes. The service collected funds from the business but did not deposit the taxes with the IRS. The business discovered this when receiving IRS notices for unpaid taxes.
Compliance determination:
Not compliant. The business remains liable for the unpaid taxes regardless of the payroll service's actions. The employer is responsible for ensuring taxes are deposited—delegation does not transfer liability. Responsible persons may face TFRP for trust fund portions.
Key insight:
Payroll tax compliance requires both timely deposits and timely filing. Using a payroll service does not transfer liability—the employer remains responsible. Employment tax problems escalate quickly and can create personal liability for anyone who controlled business finances.
Frequently Asked Questions
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This guide explains payroll tax requirements. A business compliance review examines your IRS employment tax records to determine what's been filed, what's been paid, and what remains outstanding.
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