How to Reduce Payroll Tax Penalties

If you are a business with even one single employee, you can be assessed payroll tax penalties if you do not pay appropriately each time you issue a paycheck to that employee. This is called the "pay as your go" system; the entire federal tax system operates this way. Even a self-employed individual failing to pay quarterly income taxes will owe a penalty. The best way to avoid the penalty is to make all payments on time. However, if you are late on a payment, there are options to reduce and eliminate the penalty all together.

How Penalties are Calculated

The penalty schedule is as follows: two percent assessment for one to five days late; five percent assessment for six to 15 days late; 10 percent assessment for any greater. The way the IRS calculates the penalty is part of the confusion that can lead to higher amounts owed. The IRS will automatically use any money you pay on payroll taxes to cover any remaining balance you owe. This is where the confusion starts. For example, if you pay your employees once a month, you will have three payments each quarter. If you underpay on the first payment, your next payment will go toward the remaining balance; this means your second payment will also be insufficient. The cycle can continue, resulting in a host of late or missed payments and correspondent penalties.

How you can Reduce the Penalty

When you file Form 941 to report the payments you made, you can pay any additional funds you owe at that time. You will want to apply these funds in a way that reduces the most possible for you, getting your penalty down to a very small amount. Therefore, it does not make sense to apply the funds to the most recent underpayment in a cycle of underpaid payroll taxes. Instead, elect to apply the money toward the first payment that was insufficient. Any balance that had been applied to this first payment from another pay cycle will be transferred back to the original pay cycle. If all other payments were sufficient for their respective periods, they will not longer be considered too small, and the penalty will be greatly reduced. 

How you can Eliminate the Penalty

You are permitted to ask for abatement of a penalty if you feel it was a one-time occurrence. For example, many new businesses are late on their first payroll tax payment. They make all concurrent payments on time. This indicates they had full intention to pay and corrected the problem immediately. A similar argument may be made if you have a long history of making payments on time but missed one payment on account of extenuating circumstances. You can file for abatement with the IRS explaining those circumstances. You must provide the reasons you wish the penalty to be lifted in writing. After you file, you have no further authority to contact the IRS. Instead, you will hear in writing whether your abatement was approved within a few weeks.

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