How To Reduce Payroll Tax Penalties
Payroll tax penalties, IRC §6656, can be devastating. A payroll penalty usually hits businesses that can least afford them, new business and businesses with weak cashflows. There are things businesses can do to reduce a payroll tax penalty.
The first thing to consider is to ask the IRS to abate (eliminate) the payroll tax penalty. This is very feasible if the underpayment of the payroll tax deposit is the exception, not the rule. For example, if a new business was late with its first payroll deposit, but paid all other payroll deposits on time, the business might be able to get the payroll penalty abated. Another example would be a business that had a long history of paying payroll deposits on time, but was late for one deposit only. Basically, to get the IRS to abate a payroll tax penalty, the employer needs to show that the late payroll deposit payment was an unusual event. If the payroll tax penalties cannot be abated, you should look at other strategies.
You can also try to use the "First Time Abatement" request the IRS. If you have not had a penalty within the prior three years, you can request a First Time Abatement. When you receive an assessment letter for payroll tax penalties, request a First Time Abatement of the penalty if you qualify and if you cannot use a "reasonable cause" argument. A reasonable cause argument is better to try first. You can use reasonable cause as often as it applies. The First Time Abatement is like a get out of jail card that can be used once every three years.
If you only skipped some payroll tax payments each quarter, you might be able to use IRC §6656(e). IRC §6656(e) lets the taxpayer, for a calendar quarter, allocate payroll deposits (payments) to payroll liabilities. This can result in significant penalty reductions. The IRS Interest & Penalty Calculator can use IRC §6656(e) to automatically simplify this difficult computation. To do this, run the IRS Interest & Penalty Calculator to create a Payroll Deposit Penalties schedule. Reply to the IRS payroll tax notice within 90 days of the notice. In the reply, include "Pursuant to IRC §6656(e), the taxpayer hereby requests that payroll tax deposits be applied to payroll tax liabilities as indicated by the attached Payroll Deposit Penalties schedule." And, include a copy of the Payroll Deposit Penalties schedule. This has worked very well based on our customer's feedback.
The payroll tax penalty is figured by multiplying the amount of the late payment by a payroll tax penalty percent. That percent is based on the number of days late as shown in the table below:
If the employer has not designated what payments get applied to what payroll liabilities, the IRS will figure penalties for the quarter by applying the earliest payrol tax payments to the earliest payroll tax liabilities. That sounds pretty reasonable, but with this method, if the first payment is made late, all other timely paid payroll deposits also become late.
For example, lets use the following scenario:
The way the IRS applied payments to payroll tax liabilities causes all 3 deposits to be late and subject to the payroll tax penalty. The IRS applied some of payment 2 to unpaid liability 1. This now made liability 2 underpaid. Then the IRS applied some of payment 3 to the unpaid portion of liability 2. You get the picture. This causes a cascading of payroll penalties. Even the IRS thinks this is unfair! This problem can be corrected by properly using IRC §6656(e) on a timely basis. If IRC §6656(e) is properly used, only 1 deposit is late, not all 3! This can be significant. Read on...
The IRS may now accept the employer's designation of how payments are applied to payroll tax liabilities. In the above example, if the payment that was made with Form 941 is applied to the first payroll liability, only the first payroll tax deposit would have been subject to payroll tax penalty.
In Rev. Proc. 99-10, the IRS illustrates this with an example. In the example, the IRS notice shows a $500 payroll tax penalty. When the employer designates how the payments are to be applied, the penalty drops to $200. For more specific details see, IRC §6656(e) and Rev. Proc. 99-10, but read on before you do.
This sounds simple enough. WRONG! This is only simple if there is only one underpaid payroll tax deposit per quarter. If there are more than one underpaid payroll tax deposits per quarter, what is the optimal order for applying payroll deposits to payroll liabilities? If there are 7 payments per quarter, the payments can be arranged 5,040 ways. If there are 8 payments, those payments can be arranged 40,320 ways. How can the employer come up with the minimum payroll tax arrangement of payments?
If you would like help with this process, do not hesitate to contact us at "info AT denvertax.com". (We are listing the email address this way to reduce SPAM! Replace the AT with @ and remove the spaces.)
With the DTS IRS/State Interest & Penalty Calculator, the program can calculate the lowest possible payroll tax penalty for up to 10 payments per quarter. In other words, if there are 10 payments per quarter, the program will compute for you the lowest quarterly payroll tax penalty out of over 3,600,000 arrangements of payments.
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