Using payroll taxes for working capital: path to financial ruin.

• Author: Meder, Anthony

When cash is scarce, it may seem easy to use the taxes withheld from employees' salaries for working capital, but the IRS has swift and severe penalties for not paying taxes owed. It is especially harsh for unpaid withholdings; interest and penalties can quickly triple the original liability. Business bank accounts can be seized; criminal penalties may involve prison. Any officers, managers or executives with filing authority can be personally liable for unpaid withholding taxes, regardless of the business's legal form. There is no protection for personal assets. This item details these penalties to provide a better understanding of the consequences of using withheld taxes as working capital.

Background

A positive net cashflow means that a business is generating sufficient cash to cover its required payments. However, many businesses experience period of negative cashflow. These periods are often seasonal and anticipatory. A common external source of cash during these periods is a revolving line of credit; the business can take advances as needed for working capital. However, when this is not available, the business may haw to delay payments on debt or other obligations, thus diverting working capital.

Delaying payments on accounts payable is frequently used to increase available cash. If a company chooses to use withheld payroll taxes for working capital, the IRS and local tax authorities will impose swift and severe punishment.

Potential Penalties

Types of payroll taxes: There are two categories of payroll taxes. The first is taxes that are the business's responsibility, including the employer portion of FICA and unemployment taxes; they are paid from company assets. The second is taxes that are the employees' responsibility, but the employer collects them, predominantly withheld income tax and the employee portion of FICA; they are withheld from the employees' earnings and remitted to the IRS or other tax agency. This second type is considered held in trust by the employer (trust fund taxes).

Consequences for late or partial payments: The Service imposes civil and criminal penalties on businesses that do not pay the entire tax when due. Sec. 6621(a)(2) provides an interest rate for the underpaid tax of 3% over the Federal short-term rate. If the underpayment is more than $100,000, the rate becomes 5% higher, under Sec. 6621(c). The short-term rate is determined quarterly and is based on the average yield of Federal securities with...