Business owners must collect, report and submit payroll taxes as required by federal and state laws. It is important that payroll systems and processes are accurate and efficient to meet federal and state obligations. Otherwise, a corporate officer or other responsible party (as defined by the IRS) may be personally liable for payroll taxes that are not reported or deposited, even if someone else processes payroll.
Payroll errors are common and costly for any business. Construction contractors should be especially careful to properly classify workers, pay prevailing wages and certify payroll on government projects, and pay state and local employment taxes at the right rate and for the correct amount of time a worker is on the job.
The IRS estimates that roughly 40 percent of small businesses incur an average of $845 per year in IRS penalties due to payroll mistakes. The most common mistakes include the following.
Failing to register the business
Construction contractors must register their business with the federal government in each state, municipality and city in which they conduct business, and they are required to withhold and pay income and employment taxes.
Deducting the wrong amount
Although federal employment taxes are straightforward, they’re more complicated at the state and local level. Each state, municipality and city has its own rules, and tax rates frequently change. Systems and processes must be established to ensure the responsible party is aware of these changes and incorporates them into the company’s payroll system.
For example, Philadelphia reduced its wage tax and changed its structure on July 1, 2017. Prior to this, Philadelphia’s wage tax rate was 3.9004 percent. Now, the wage tax rate for residents is 3.8907 percent and non-residents 3.4654 percent. To correctly calculate the wage tax, two different rates should be used based on where an employee lives and how much of their time was spent working in the city.
The federal government and some states may have different rules on classifying a person as an employee or contractor. The federal government uses the answers to 20 questions to determine how a worker must be classified. In New Jersey, worker classification is based on the following criteria.
- The worker’s performance must be free from the business’s control or direction.
- The service the worker provides must be outside of the usual course of the business.
- The worker currently has or has had professional engagements with other businesses, industries or trades.
It could be costly if the IRS or the state of New Jersey finds a worker is misclassified without reasonable cause. The business owner and/or responsible party could be held liable for paying employment taxes, as well as penalties and interest.
Not Paying Taxing Authorities
The Trust Fund Recovery Penalty (TFRP) can be imposed by the IRS for:
- willful failure to collect tax;
- willful failure to account for and pay tax; or
- willful attempt in any manner to evade or defeat tax or the payment thereof.
The term “willful” is defined by the IRS as “intentional, deliberate, voluntary, and knowing, as distinguished from accidental.”
TFRP penalties can be steep and complicated. For example, the penalty for not filing an Employer’s Quarterly Federal Tax Return (Form 941) on time is 2 percent for being one to five days late, 5 percent if six to 15 days late, 10 percent if more than 16 days late or within 10 days of first notice from the IRS. The maximum penalty is 15 percent. Consult IRS Publication 15: Employer’s Tax Guide for a complete description of TFRP penalties.
Making late deposits
Deposits are applied to the most recent liability and are due by the 15th of the month. The company may be assessed a penalty for un-deposited funds, even if the money is deposited in the subsequent period.
Failure to prepare W-2 and 1099 forms
Employees must be provided with a W-2 by Jan. 31. A $50 penalty may be imposed for late or incorrect W-2 statements. Form 1099-MISC must be issued to each independent contractor paid $600 or more during the tax year. The contractor must receive Form 1099-MISC no later than Jan. 31 and the IRS on or before Feb. 28. If a business submits Form 1099 within 30 days from the due date, the penalty is $30 per form. If it is filed more than 30 days late but before Aug. 1, the penalty is $60 per form. The penalty increases to $100 for any form filed after Aug. 1 or not filed at all.
There are many other things to consider. Hiring a payroll processing company can help eliminate mistakes while improving efficiencies. Having systems in place to tie payroll to projects can help with scheduling, estimating and budgeting. Submitting hours worked per project daily can ensure accuracy and reduce over or under payments. Consult a tax professional on best practices to improve payroll processing.