Payroll Penalties are Almost Impossible to Get Rid Of

I preach this to my clients all the time: payroll is a big deal. If you choose to go down the road of having employees, you MUST jump through the hoops.

My tax blog buddy Joe Kristan wrote last Wednesday about a court case in California where a McDonald’s franchisee used a payroll service to process payroll … and the payroll service stole the tax withholdings instead of depositing them with the government.

The IRS hit the franchisee with over $100,000 of penalties. The company appealed, but a federal court ruled in favor of the IRS, and so it looks like the company is stuck with a massive amount of penalties.

Not only do I tell my clients that payroll is a big deal, I also tell them the following: the payroll system is designed to screw you over for committing foot faults. The penalties are almost impossible to get waived.

Since May, I have helped four clients who process their own payroll and who have committed sins of various forms.

In one case, a one-person S-corp made a deposit in the last month of the quarter. They paid the tax liability for the quarter in full and before the end of the quarter. The IRS hit them with a penalty because the client is considered to be a monthly depositor, and so the deposit should have been broken up into monthly payments instead of just one payment.

Ridiculous? Most people would say yes.

Something I could get waived? No, because the IRS was technically correct.

The other 3 cases all follow similar strains. Small businesses just trying to make it in the world … a few tax deposits are late and boom — $10,000 of penalties in one case. Several-thousand dollars in another.

And another client has become so overwhelmed with the burdens of payroll that they are tens of thousands of dollars behind in making their deposits and I’m just trying to help them fend off the IRS wolves.

The only “out” in most payroll penalty situations is to try and argue reasonable cause. I have, in the past, written eloquent letters in defense of my client and asking for the penalties to be waived… only to have the IRS reject it with virtually no consideration.

One time I helped a small business who agreed that they should pay some penalties, but not the massive amount the IRS was assessing. So I wrote a reasonable-cause letter. It was eloquent. It laid out a great defense of the client. We asked for a reduction of some, but not all, of the penalties.

I received a rejection letter back from the IRS almost instantaneously.

This is why, when talking to entrepreneurs, I tell them that the single worst thing they can do is hire employees without knowing what they’re getting into. It’s why I warn sole proprietors who are thinking of becoming S-corps, to beware of the specter of payroll that will hang over their head once they make the conversion.

Payroll is a big deal. The system of penalties is designed to screw you over. There’s virtually no way out of the penalties.

Fair? Probably not. But that’s how it is, and savvy business owners need to understand the realities and make sure payroll is ALWAYS something they have at the top of their minds.