When it comes to depositing federal income taxes and FICA taxes withheld from employees' wages, the government holds employers to strict timelines. Pay late and an IRS penalty notice is almost sure to follow. Fail to pay and the IRS may pursue not just the company, but also so-called “responsible persons” — officers, employees, and other individuals who are responsible for collecting, accounting for, and paying  the company's payroll taxes. In Trust Federal employment tax withholdings are considered government property, which an employer holds “in trust” until the money is paid to the IRS. The penalty for willfully failing to turn over the tax amount to the government is known as the 100% trust fund recovery penalty because it is equal to 100% of the unpaid taxes. In the Hot Seat In one recent case, the IRS was successful in its efforts to hold a corporation's former CFO and CEO personally liable for the penalty. The company, which eventually declared bankruptcy and liquidated, failed to remit more than $5 million in payroll taxes over a period of several years. In granting the IRS summary judgment, the court noted that the CFO had the authority to direct and decline creditor payments, sign checks, oversee general cash flow, and hire and fire employees in the accounting department. When questioned, he admitted that he knew that other creditors were being paid before the IRS. The CEO held general control of the company's operations, could hire and fire employees, and had the authority to sign checks. Although he was told about the tax problem, he did not take action to correct it, instead delegating the problem to the CFO. According to the court, “his apparent choice to turn a blind eye and a deaf ear” to warnings that the payroll taxes were not being paid, while shifting blame to the CFO, did not relieve him of personal liability. Assessment Period The IRS may be preparing to become more aggressive in its pursuit of the penalty. In recent advice, the agency's chief counsel said that the government has no time limit to assess the penalty if an employer has committed fraud, willfully attempted to evade tax, or failed to file an employment tax return.

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How a company handles business expenses incurred by employees, such as travel and entertainment expenses, makes a difference at tax time. Assuming the company, not the employee, will ultimately be paying the bills, there are two basic choices: An Accountable Plan With this method, employees substantiate their expenses to the company and the company pays the expenses. Because expenses are reimbursed dollar for dollar, employees do not have to report any income as a result of the arrangement and the employer owes no payroll taxes on the amounts. The company deducts the expenses (subject to the usual 50% limit on meal and entertainment expenses). Within these broad parameters, a business has some flexibility as to how its accountable plan is set up. For example, if requiring employees to pay out-of-pocket and then request reimbursement will present problems, the business might decide to advance money to employees for their expenses. However, for the plan to be considered an accountable plan, employees would have to return any excess amounts advanced to them. Other possibilities include having employees charge their expenses to a company charge card or having bills sent directly to the business. A Nonaccountable Plan This method simplifies the company's recordkeeping because employees are not required to submit receipts or other documentation for their expenses. The company simply gives employees an allowance to cover their expenses, and employees keep any amounts they don't spend. Expense allowances are included in employees' wages, and all the usual payroll taxes apply. The company deducts the wages and taxes. Employees may deduct their business-related expenses, assuming they itemize their tax deductions (limits apply), and have the appropriate records. If you'd like to discuss the way your company handles employee business expenses, please let us know.
While it isn't always obvious whether workers are employees or independent contractors, businesses should make a concerted effort to get it right whenever they hire someone new. The determination is important for employment tax purposes and could affect the company's benefit plans as well. FICA and Unemployment Taxes Businesses have to withhold and pay Social Security and Medicare (FICA) taxes on wages paid to an employee. At a 7.65% tax rate (1.45% on 2006 wages exceeding $94,200), the employer's share of FICA taxes can add up fast. No withholding or FICA payment is required for an independent contractor  because a contractor is “self-employed” and personally responsible for the payment of self-employment taxes on his or her earnings. Federal and state unemployment taxes are additional expenses of having an employee that can be avoided by hiring an independent contractor. Employee Benefits Health and retirement benefits are expensive to provide, so companies naturally want to avoid covering workers that can rightfully be excluded. However, denying coverage to “contractors” who later prove to be employees can have serious consequences. A case involving software giant Microsoft brought national attention to this issue several years ago. A number of freelancers were working for Microsoft at the time the IRS examined the company's employment records for compliance with the tax laws. Despite written agreements stating otherwise, the IRS decided that Microsoft's freelancers were actually the company's employees for withholding and employment-tax purposes based on common-law principles. This ruling prompted several of the freelancers to ask for employee benefits. Microsoft refused the benefit requests, and the controversy ultimately went to a federal appeals court, which decided that the freelancers were entitled to participate in the company's 401(k) and stock purchase plans. The Microsoft case stands as but one example of the fine line that so often exists on the worker classification issue.