Avoiding Payroll Tax Problems
Don't get stuck paying excess payroll tax penalties.
The Internal Revenue Service can be tough on collecting income taxes, but it’s even tougher where payroll taxes are concerned. Mistakes in withholding and paying withheld taxes can be expensive, even when a third-party payroll service is involved, as the IRS recently revealed (TIGTA 2015).
Operating a business with employees, you face countless rules about the payments you make to your staff. There are regulations that dictate when—and which—workers must be paid overtime, the amount of taxes that must be withheld and when those taxes must be paid to the IRS. Unfortunately for many personal training businesses, the potential for even more payroll problems increased recently when the U.S. Department of Labor proposed new payroll-related rules.
In this article, you’ll learn what these new rules are, what you need to know about payroll taxes and how the new IRS Early Interaction Initiative may help you avoid penalties.
Overtime Burden Increased
A recent study conducted by CareerBuilder™ found that almost two-thirds of American workers think the 8-hour workday is a thing of the past (CareerBuilder 2015)—and the Department of Labor agrees. The DOL has proposed new rules that would extend overtime protections to nearly 5 million so-called white-collar workers within the first year of the regulations’ implementation (DOL 2015a).
The DOL’s current rules do not limit either the number of hours in a day or the number of days in a week that an employer may require an employee to work, as long as the employee is at least 16 years old. While the DOL places no limit on the number of hours of overtime that may be scheduled, the rules do require employers to pay covered employees not less than one and one-half times their regular rate of pay for all hours worked in excess of 40 in a workweek, unless the employees are otherwise exempt (DOL 2015a; DOL 2015b).
The DOL’s proposed rules would close a loophole in the overtime regulations—originally meant for highly compensated executives, administrators and professional employees—that applies to workers earning as little as $23,600 a year (DOL 2015a). Under the proposed rules, employers would be required to pay overtime to workers making up to about $50,000 annually. Even those persons classified as managers or supervisors and currently exempt from the overtime rules would qualify. The finalized rules are expected to take effect during 2016 (DOL 2015b).
Despite concern about keeping overtime costs down, several states seem poised to follow the lead of California, where rules similar to the current proposal were adopted over a decade ago and where even the act of reading an email is considered “work” and is eligible for overtime pay.
The DOL’s Other Rules
Of course, not all employees or all personal training businesses are covered by the DOL’s rules. Exceptions include employees of retail stores and service establishments that have annual gross receipts less than $500,000; outside salespeople; and executive, administrative and professional personnel (DOL 2015a).
Remember, however, that personal training businesses not covered by the federal laws are still, in all likelihood, subject to similar state overtime laws. Not too surprisingly, if an employee is subject to both the state and the federal overtime laws, that employee is entitled to overtime pay according to the standard that will provide the higher rate of pay.
Many industries hire part-time or seasonal workers, and those employees are subject to the same tax-withholding rules as other employees. In most cases, employees are considered part-time if they work fewer than 35 hours a week. However, according to the Fair Labor Standards Act, the employer is responsible for determining whether the employee is full-time or part-time (Cohn 2015).
Unfortunately for those in the fitness industry, there is no definitive answer to whether part-time or seasonal employees are exempt from or entitled to overtime. Wage and employment law varies from state to state, so checking local regulations is vital. (To find contact information for your state’s labor department, go to www.dol.gov/whd/contacts/state_of.htm)
Is the Worker Really an Employee?
Employees are treated as taxable workers subject to payroll taxes, while independent contractors are responsible for paying their own taxes. Because the lines between independent contractors and employees are not always clear-cut, both the DOL and the IRS are frequently skeptical of either label.
Usually, workers are considered em-ployees if the business owner or manager has the right to direct and control the way in which they do their work, rather than merely the results of the work. However, just because a worker agrees to be paid as an independent contractor doesn’t mean that’s the legal way to pay that person.
The Affordable Care Act Confusion
The Affordable Care Act has redefined full-time employment, at least when it comes to its controversial healthcare benefits and penalties. First, you should understand that the ACA’s taxes and tax credits are based on the number of full-time equivalent employees and their average annual wages—
on the number of full-time employees (TIGTA 2015). In simple terms,
or FTE, equals the total number of full-time employees, plus the combined number of hours worked by part-time employees divided by 30. Seasonal employees, contractors and business owners don’t count toward the total for most operations.
In addition, you need to consider the Medicare tax hike. The Medicare Part A tax is paid by both the employee and the employer. Often overlooked, however, is the fact that an individual or a personal training business with profits over $250,000 faces a 0.09% increase (from 2.9% to 3.8%) on the current Medicare Part A tax (CCH State Tax Law Editors 2016).
Since this tax is split between the employer and the employee, each will see a 0.45% increase. Small businesses making under $250,000 are exempt from the tax. Employees earning less than $200,000 as an individual, or $250,000 as a family, are also exempt (CCH State Tax Law Editors 2016).
So what’s the big deal with all this tax information? The government is cracking down on small businesses that have problems paying delinquent payroll taxes. Payroll taxes must be collected as withholding and turned over to the IRS. (Some employment taxes are withheld from workers’ pay, while the employer pays a matching amount for some workers and pays fully for others.) Failure to collect and pay those payroll taxes can mean a whopping 100% penalty tax—accruing additional penalties and interest the longer it goes unpaid (IRS 2016).
Approximately 40% of small businesses use a third-party payer for tasks ranging from paying employees to paying federal employment taxes (TIGTA 2015). Employers using a payroll processor, an accountant or another provider to handle their payroll, withholding, matching, remittance and/or reporting responsibilities sometimes suffer from miscommunication between the parties. Miscommunication can result in tax deposits not being made and reporting not being done as required. This, in turn, can result in mounting tax liabilities, interest and penalties that are extremely costly and risky to the business.
Looking at the IRS in a recent audit, the Treasury Inspector General for Tax Administration—referred to as TIGTA—evaluated whether the IRS’s own controls are adequate to protect the taxpayer’s and government’s interests when third-party payroll providers are not compliant with payroll payment and filing requirements (TIGTA 2015). After all, the employer is the one responsible for reporting the withheld amounts and paying them to the IRS. Until the IRS is able to connect the employer with any missing reports or payments for withheld taxes, the clock continues to tick on those unpaid payroll taxes—as well as the accrued interest and penalties.
Reducing Payroll Tax Penalties
One of the nastiest and most feared taxes currently being imposed is the Trust Fund Penalty Tax: a whopping 100% penalty on payroll taxes that you withhold from your employees but don’t forward to the IRS (IRS 2016). The fear of this tax stems from the IRS’s authority to assess the penalty on all “responsible parties,” a label that can include the owners, shareholders, partners, members, managers and officers in your business.
Fortunately, you can avoid payroll tax penalties. A reduction in the payroll tax penalties that have been levied as the result of an IRS audit, or even penalties resulting from errors detected by your business itself, can begin when you ask the IRS to abate or eliminate the payroll tax penalty. Yes, the IRS has the discretion to waive penalties, especially if the penalty is the exception, not the rule.
The Early Interaction Initiative
The good news is that the IRS has introduced a new program, the Early Interaction Initiative, that will more quickly identify employers who are falling behind on their payroll or employment taxes and will help them get caught up on their payments and reporting responsibilities (IRS 2015). Designed to help employers stay in compliance and avoid needless interest and penalty charges, the initiative will identify employers who appear to be falling behind on their tax payments—even before an employment tax return is filed.
This new initiative will monitor deposit patterns and identify employers whose payments decline or are late. Employers identified under this initiative may receive a letter reminding them of their payroll tax responsibilities and asking them to contact the IRS to discuss their situation. In addition, some employers may receive automated phone messages from the IRS, providing information and offering assistance.
Obviously, understanding the basic rules for withholding payroll taxes—and the requirement to pay those withheld amounts—on the wages of all employees in your business is a good start. Remember, however, that this is not a place where you should go it alone.
If your payroll is relatively stable (say, four employees getting a paycheck for the same amount every 2 weeks), handling the payroll in-house might be possible. However, if the process starts to get tricky (different paychecks, more frequent payments, more employees), consider hiring a reputable payroll service. After all, it doesn’t take more than one or two penalties per year to make a payroll service look cheap.
If your business is handling payroll on its own, consider overpaying each deposit. Setting aside a small amount as a cushion and carrying it forward every quarter could help you avoid being charged a penalty if mistakes are made. Above all, you may want to obtain guidance and advice from a competent, qualified advisor such as a CPA, an enrolled agent or another tax professional. n
CareerBuilder. 2015. Are we becoming 24-hour work- ers? CareerBuilder Survey explores the demise of 9 to 5. Accessed Feb. 5, 2016. www.careerbuilder.com/share/aboutus/pressreleasedetail.aspx?sd=7/23/2015&id=pr905&ed=12/31/2015.
CCH State Tax Law Editors. 2016.U.S. Master Tax Guide. Riverwoods, IL: Wolters Kluwer.
Cohn, M. 2015. IRS debuts program to get employers caught up on payroll taxes. AccountingToday.com. Accessed Feb. 3, 2016. www.accountingtoday.com/news/tax-practice/irs-debuts-program-to-get-employers-caught-up-on-payroll-taxes-76635-1.html.
DOL (U.S. Department of Labor). 2015a. Overtime. Accessed Jan. 26, 2016. www.dol.gov/dol/topic/wages/overtimepay.htm.
DOL. 2015b. Notice of proposed rulemaking: Overtime. Accessed Jan. 25, 2016. www.dol.gov/whd/overtime/NPRM2015/.
IRS (Internal Revenue Service). 2015. New early interaction initiative will help employers stay current with their payroll taxes. Accessed Jan. 27, 2016. www.irs.gov/uac/Newsroom/New-Early-Interaction-Iniative-Will-Help-Employers-Stay-Current-with-Their-Payroll-Taxes.
IRS. 2016. Publication 15 (Circular E, Employer’s Tax Guide). Accessed Jan. 28, 2016. www.irs.gov/pub/irs-pdf/p15.pdf.
TIGTA (Treasury Inspector General for Tax Administration). 2015. Processes are needed to link third-party payers and employers to reduce risks related to employment tax fraud. Accessed Jan. 26, 2015. www.treas.gov/tigta/auditreports/2015reports/201540023fr.html.