Payroll Tax Penalties, When the IRS Sends a Letter


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“Payroll Taxes are Due, with Penalties and Interest"

At least that is what the letter from the IRS says. First thing, don’t panic. Quoting Daniel J. Pilla’s study for the Cato Institute “About 40 percent of the revenues the IRS collects through penalty assessments are abated when citizens challenge the penalties. "

So we now know the odds are good that the IRS is wrong or will blink first. What do we do?

The normal problems with payroll taxes are.

Failure to File.

Taxes under reported.

Taxes under deposited.

Taxes deposited late.

Any of these can create a situation where the services charges penalties and interest against a business and then sucks up subsequent tax deposits creating additional late and short payments simply exacerbating the situation. We will get to that later.

Read the notice from the IRS. It should tell you why they are charging a penalty and interest and how it is calculated. If the notice does not lay out that information, you have missed the first notice from the IRS. That is not at all unusual. If you don’t have the first notice call the IRS and get all the information from them. Also ask them to fax you a “Statement of Account" for the period and type of tax in effect. This will show you what they have on the IRS file, without regard to whether it is correct or not.

Failure to file.

The IRS says you never filed a return and they have created a return for you. They will estimate taxes due in an amount they know exceeds what would be reasonably due based on your account. They do this to get your attention. Many people, if the estimated amount were too low, would just pay it. The IRS does not want that to happen so they always over estimate if they create a “Substitute Return" and file it for you.

The answer to that is to send a copy of the return. If you filed it certified mail send a copy of the receipt when it was sent proving the date and a copy of the return receipt showing it was received. One tip is never sending more than one return in an envelope. The clerk opening the envelope may staple them together and only the top return will ever be reported as being received. If you didn’t send it certified in your accompanying letter talk about your history of filing on time and this one was surely just misrouted. If you have collateral proof of the filing date like a cancelled check that was sent with the return quote that information or even include copies. If the return was due on the 15th and the check attached cleared your bank on the 18th that is pretty convincing that the report was actually there by the 15th.

Taxes under reported.

Find out why they say that. Have they transposed a number when they hand entered the return? That happens with regularity. Have they just pulled a number out of their hat? That happens periodically. Once we received two notices for two different customers on the same day saying they had overpaid their 940 taxes and offering them each a refund of over $36,000.00 each. The total 940 tax deposits for the two clients combined were less than $2000.00. And no, I did not let them apply for and receive the checks.

Again send the IRS a copy of the return that you filed. If the return is wrong then send the IRS a corrected form such as a 941-C to correct the original filing. For instance, if you put second quarter figures on the third quarter report. There won’t be a penalty for late filing if in fact you filed an original return on time even if it was incorrect. A tip is if you cannot prepare the actual return on time, estimate it and file it. Then file a corrected return when you can, this avoids a late filing fee.

Taxes under deposited.

They say you made fewer or smaller deposits than you reported. Check their list and dates of deposits against yours. Don’t accept their word for when it was made. You have the proof in your files. We have noticed a real problem recently. EFTPS payments are not being shown with the date in the electronic file the same as on the “IRS Statement of Account. " How some programmer messed that up is beyond me. So prepare the data showing your proof that the payments were made on time, bank deposit slips, EFTPS confirmations or whatever proof you have. Package up copies and send them to the IRS with a letter of explanation, and a request for them to update their records.

If in fact you missed a deposit, it happens, make it immediately and ask for abatement anyway. Site valid reasons why the deposit could have been inadvertently missed. Discuss steps you have taken to make sure it won’t happen again.

Taxes deposited late.

See taxes under deposited and do the same thing with dates. Document and send letters. Don’t give up. Just because the first person at the IRS turns you down literally means nothing. They almost always turn down the first request for abatement of a penalty. Dealing with the IRS is a long series of no’s followed by a single yes. When you do get the yes, shut up and walk away.

One of the favorite tricks of the IRS involves a string of deposits. Let’s say you were suppose to make 12 deposits of $1000.00 each the 15th of each month starting Feb 15 and ending Jan 15th for January through December. The second deposit is missing, and the check never got cashed. You don’t know what happened. The IRS will take the third payment and apply it to the second month’s taxes but it is late so they charge a penalty. Now the fourth month’s deposit gets applied to the third month’s taxes but it is also a month late so there is another late paying penalty. You will quickly have 10 late payment penalties and the 12th month penalized as not being paid at all. The penalties exceed the taxes missing. The service cannot due this though they will try. If you designate the third deposit for the third month taxes they must apply the payment there regardless. If they don’t record them that way you can force them to do so, it is their regulations that say they must follow it. Accept the penalty only on the one month and then ask for abatement anyway. If you have never had a late payment the IRS is suppose to give you a free one anyway.

If you have a valid business reason that a penalty has occurred in spite of good due diligence on your part the IRS is suppose to abate the penalty. Understand that IRS employees may be gauged by how much revenue they bring in (the IRS vehemently denies this but ex IRS employees don’t always). When that is true they don’t want to abate penalties regardless. Another trick they have is to offer a reduced penalty as a favor, when in fact they should have zeroed it out. Or they will offer to abate penalties on two quarters if you pay the third. It is normally not a good idea to accept these offers. You can do better. Keep writing letters and filing documents at the higher and higher levels until one person gets reasonable and says yes. Then take that yes and run.

Can an ordinary citizen do this? Sure! Is it easier for a payroll tax professional? Sure! The IRS is far more likely to listen to a CPA than a citizen. The CPA knows what buttons to push and how to go to the next level. An ordinary citizen may not. The CPA is far less likely to get emotionally involved than the citizen whose pocket is being emptied.

Your payroll service provider should have CPAs on staff to handle these situations for you. If not, seriously consider a payroll service provider that does. Because when, not if, the IRS crews up your regular CPA will charge you full rate to solve problems that should be solved by your payroll provider for free.

Charles J. Read, CPA has been in the payroll, accounting and tax business for 30 years the last fifteen in private practice. Mr. Read is the author of “How to Start a New Business" and is the owner a paperless payroll company, a full service payroll service provider and RMARK Financial Service a small business tax, consulting and bookkeeping firm. See an excerpt from his interviews on William Shatners “Heartbeat of America" television show on his websites linked above.


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