Tax Lawyer's Blog

One of most frequent problems we see is the small business that is several quarters behind in paying its payroll taxes.

There are many contributing factors to this, but usually we find that the business has had difficulty paying its landlord, suppliers and vendors and, to avoid an eviction or lawsuit, it makes the fateful (and often fatal) decision to stop making its payroll tax deposits.

In the overwhelming majority of the cases the small business owner truly believes that he will be able to catch up on the company’s delinquent payroll taxes at a later date.

It rarely happens.

Here are the 5 biggest mistakes we see small business owners make in connection with payroll taxes:

1.  Poor Record-Keeping and Failure to Budget Expenses

Failing to make timely payroll tax deposits is a symptom of a problem, not the problem itself. The reason people stop or delay paying their payroll taxes is because they need the money for something else.

This is almost always a result of poor bookkeeping and a failure to budget properly.

Most small businesses are well-advised to consider either leasing their employees or outsourcing their payroll function to a company like ADP or Paychex. 

If you lease your employees, you will have no payroll and a payroll tax problem can never arise. 

If you outsource your payroll to a reputable payroll service, it greatly increases the likelihood that all of your filings and tax deposits will be made on a timely basis. 

2.  Owners Living Beyond Their Means

Sometimes business owners, when times are good, lock themselves into a lifestyle that they will not be able to sustain should there be a downturn in the economy.

And there’s always a downturn. 

Before you give yourself a big bonus so you can buy a Catamaran or a new Harley, make sure your company has at least six months overhead available in cash or cash equivalents. If that isn’t possible, you should have available at all times a line-of-credit equal to that amount. 

3.  Misunderstanding of the Tax Laws Regarding Withheld Payroll Taxes

When you hire an employee you agree to pay them a salary or hourly rate before taking out federal withholding and social security taxes (PDF). As an employer, you are required by law to withhold these amounts at the source and promptly remit them to the Internal Revenue Service.

These withholdings are never your money. So, if you use these funds for your own benefit or the benefit of your company, you are considered to have stolen them from the federal government.

As a small business owner you must get used to the idea that amounts withheld from employees’ checks are not and never will be your money.

4.  Failure to Establish and Maintain a Separate Payroll Bank Account

Most small businesses use their general operating account from which to pay their payroll. This means that the portion of the employees’ payroll that has been withheld is co-mingled with the company’s funds.

This is a dangerous practice, especially for businesses that don’t keep good books and records.

The problem with using one account is that it looks and feels like all the money in that account belongs to the company and can be used, as needed, to pay company expenses. The truth is, however, that at no time are the withheld payroll taxes (also called the Trust Fund) the property of the company.

5.  Co-mingling Personal and Business Finances

One of the most common mistakes we see is the small business owner who uses his business bank account as his personal bank account.

This co-mingling of business and personal funds makes it difficult for the business owner to assess the profitability of his business and, therefore, assess his working capital needs. The inability to properly assess and provide for working capital requirements is one of the principal causes of the failure to make payroll deposits on a timely basis.

Co-mingling can have other bad consequences, too.

If you are a corporation and you use your personal bank account as your business account or vice versa, a creditor may argue that you have not respected the corporate form. This may allow him to sue you personally for the unpaid debts and liabilities of the corporation.

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