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Payroll - Avoiding Potential Pitfalls

By Mark E. Battersby

01/01/20

Employers, all employers, are facing potentially expensive attacks on their bottom line. The U.S. Department of Labor has, for example, proposed new rules that will make 1.3 million workers earning less than $35,568 annually eligible for overtime pay. But, that’s not all.

The abrupt shutdown of a national payroll company left hundreds of thousands of workers without paychecks — and many employers liable for payroll taxes that weren’t forwarded to the IRS.

Further compounding the payroll headaches, California recently tightened the definition of “independent contractor” with many other states expected to follow suit. Not to be outdone, the IRS announced an expansion of their worker misclassification education and enforcement campaign to combat employment tax crimes.

PAYROLL TAXES

Payroll taxes withheld by employers account for nearly 72 percent of all revenue collected by the IRS. Federal payroll taxes cover Social Security and Medicare contributions, which constitute the Federal Insurance Contributions Act (FICA) tax.

Payroll taxes are imposed on employers and employees, and are usually calculated as a percentage of the salaries that employers pay their workers — seasonal and part- or full-time. Payroll taxes generally fall into two categories: amounts deducted from an employee’s wages, and taxes paid by the employer based on the employee’s wages.

Although some of these taxes are not payable by a car wash business, there is a legal presumption that if these withheld taxes are not forwarded to the IRS, it is an “unlawful retention,” and subjects the business — or a “responsible person” — to a whopping 100 percent penalty tax.

Employers know — or should know — that they must deduct, deposit, and report employment taxes accurately. As with all taxes however, the road is not always a smooth one. Little wonder, many are turning to payroll services.

PAYROLL SERVICES

Approximately 40 percent of small businesses use a third-party payer for tasks ranging from paying employees to paying Federal employment taxes. When MyPayrollHR, a now defunct cloud-based payroll processing firm based in upstate New York, abruptly ceased operations, it left hundreds of thousands of people without paychecks — and many employers facing substantial penalties and fines for payroll taxes for which they were ultimately responsible. That failure also drew attention to the increasing popularity — and the downside — of payroll service firms.

Being ultimately responsible, the failure of the payroll company to file and forward payroll taxes causes significant problems for employers because the funds have been expended but the taxes remain unpaid. It also subjects employers to the dreaded 100 percent Trust Fund Tax Penalty.

Because the IRS does not regulate payroll service companies, the collapse of this payroll firm, or any payroll firm, should serve as a reminder to car wash operators to verify the actions of payroll service providers. This should be a routine practice, regardless of the provider’s reputation and the longevity of the relationship.

Every car wash buinesses using payroll services should open their own accounts with the Treasury Department’s Electronic Federal Tax Payment System (EFTPS) and verify that all deposits are being made on-time to their payroll tax accounts.

OVERTIME RULES

The Fair Labor Standards Act (FLSA) requires the payment of a premium for overtime. The old standard of “anything over 40 hours in a week” being considered as overtime has, in many instances, been usurped by daily overtime (one-and-a-half times the regular rate of pay) and double time (twice the regular rate of pay).

The U.S. Department of Labor (DOL) has announced new overtime rules. Beginning in 2020, 1.3 million salaried workers earning less than $35,568 annually will be eligible for overtime, regardless of whether they perform managerial or supervisory duties. Under the new rules, employees who don’t perform managerial or supervisory duties must be paid time-and-a-half for any work over 40 hours a week.

Meanwhile, a number of states have, or are planning to, set their own overtime rules for workers in their jurisdictions that are above the new federal requirements.

MISCLASSIFICATION

Further compounding the payroll headaches faced by employers, the American Payroll Association highlighted the “gig” economy and the necessity for employers to stay ahead of this increasing trend. Not to be outdone, the IRS announced its own crackdown on the misclassification of workers and those in the gig economy using independent contractor labels.

Employers, including those in the car care industry, have long preferred to treat workers as independent contractors, reaping payroll tax savings, and paying no fringe benefits or other expenses associated with employees. By the same token, workers — including the owners of car washes — have reduced their own tax bills by shifting from being an employee to being an independent contractor.

Uber and other ride sharing companies have been cited as examples of the gig economy with their employment of independent contractors. However, courts in New York and California, among other states, are reaching the conclusion that some of these workers are actually employees. California has, in fact, passed a new law defining who is and who isn’t an independent contractor.

Whether on the federal or state level, the key question is usually the degree of control over the work and who exercises that control. To help, an employer can submit a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Tax and Income Tax Withholding, for a worker classification determination. There is also the IRS’s 20-factor common-law test for employers to ensure they are in compliance with both federal and state laws.

THE PENALTIES

When payroll taxes due the government are not paid, are paid late, or are paid but don’t follow the correct guidelines, employers can face severe penalties as well as accruing interest. As mentioned, using a payroll service firm eliminates the worries about submission guidelines, accuracy of payments, and getting payroll taxes paid on time. However, monitoring the payroll service is important.

When the car wash operator pays employees’ salaries, they must withhold payroll taxes and deposit those funds with the IRS. The funds are held in trust for the IRS and if not paid over are considered to be stolen by the business.

As of 2017, about 6.9 million employers had failed to pay those taxes and were slapped with over $7 billion in penalties. These unpaid payroll taxes, fines, and even property seizures, have created a “blame game,” where a so-called “responsible person” is deemed liable.

One of the nastiest and most feared taxes currently imposed is the “Trust Fund Penalty Tax,” a whopping 100 percent penalty on payroll taxes withheld from a car wash’s employees, but not forwarded to the federal government.

While a lot of businesses don’t have the money withheld from employees or their share of payroll taxes, the car wash remains liable for those taxes. The IRS has the authority to seize and sell the assets of that business.

Even worse, if the business is unable to pay or can’t pay within the timeframe the IRS demands, liability for paying can fall on a “responsible person.” That’s right, the IRS can make key employees personally responsible for the unpaid payroll taxes. They can then seize and sell the personal assets of those individuals to pay the payroll tax liabilities of the business.

How does the IRS define “responsible person?” According to the IRS, responsible persons include:

• Officers or employees of the incorporated business

• Members or employees of partnerships

• Corporate directors or shareholders

• Other individuals with authority and control over funds to direct their disbursement

COMING ATTRACTIONS

Every car wash that uses workers, either employees or independent contractors, must obviously be concerned about many things. However, in the months ahead, a number of events may make their lives even more complex, including:

• No grace period for new 2020 withholding changes. Employers may still have questions about using the revised 2020 Form W-4, Employee’s Withholding Certificate, and the new withholding methods, but no transition period should be expected. If an employer’s automated system is not current, the IRS suggests using the manual instructions in Publication 15-T, Federal Income Tax Withholding Methods.

• Don’t forget the magic (or potential headache) number 20. The number 20 is the point where many small businesses lose exemptions under many rules. For example, if a business covers workers with health insurance, they don’t have to provide coverage to a worker once he or she turns 65, since Medicare becomes the primary insurer — but only if the operation has fewer than 20 employees. Many state rules also have an employee number threshold, often around 20, so beware.

• If passed, a significant expansion of Social Security would extend the program’s solvency and expand benefits by raising payroll taxes on high-income earners.

• The IRS is hiring 600 revenue officers and plans payroll compliance sweeps around the country. Obviously, every employer needs to withhold the right amount of taxes from employees as well as understand the amounts the car wash or business must contribute.

In fact, understanding the basic rules for withholding payroll taxes — and paying over withheld amounts — on the wages of all employees in the car wash business is a good start. Guidance and advice from a competent, qualified advisor is virtually a necessity.

 

Mark E. Battersby is an Ardmore, PA-based freelance writer, specializing in finance and tax issues.



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