I’ve seen startups that want to pay everyone as a contractor, showing a zero in the payroll tax expense box on their US tax return. This would be wrong!
Officials, or those with the duties of an official, should be considered employees, not contractors. (26 CFR ยง 31.3121(d)-1(b) and Joseph M. Gray Public Accountant, Pc; 119 TC 121 (2002))
* Willful failure to pay employment tax is a crime with jail time!
* Any responsible person can be punished with the penalty
* Even an employee, outside bookkeeper or CPA can be held liable
* Once assessed, a person is presumed guilty
* Penalty is not dischargeable in bankruptcy
*There is no statute of limitations for unfiled payroll tax returns
* Officials, directors and responsible persons have personal responsibility
* It’s hard to hire good people when there are such payroll tax issues
* It is difficult to sell or exit an entity when there are such payroll tax issues
* The IRS has been aggressive in assessing and collecting penalties for employment taxes, more than with most other types of taxes.
*California passed AB5 in 2019, limiting the ability to classify workers as contractors and bringing greater scrutiny to classifying workers.
Don’t get burned by this or related problems!
* Pay officials as employees
* Don’t allow contractors or consultants to call themselves officers (for example, I’ve seen “consult CXO” on a business card, but an officer is generally considered an employee, not a consultant)
* Use a reputable payroll processor (Ask to see their “SSAE16” certification!)
* Promptly notify the processor of payroll stock options, restricted stock, other deferred or equity compensation
If there is a problem with employee classification and the subsequent payment of payroll taxes, consider the availability of voluntary compliance amnesty programs, such as the Voluntary Classification Settlement Program (VCSP, form 8952).
Move quickly to involve professionals to fix this type of problem. Tax problems generally do not improve with age and are not easily fixed without the help of an expert.
A client of mine once had an involuntary slight delay in transferring funds to his retirement fund. There was a DOL audit. His fine was less than $200, but the staff time required to investigate the problem and generate the necessary corrective paperwork cost over $10,000 with significant personal stress and complaints to his CEO.
Some small businesses recently (in 2020) discovered a new recognition of the importance of payroll, when they were unable to obtain a Paycheck Protection Program (PPP) loan as part of the Coronavirus (COVID-19) stimulus due to they couldn’t do it properly. Document your payroll expense for the prior year. Many PPP loan applications were hastily prepared, and applications with even minor errors were rejected, often without explanation.
Payroll, especially multi-state payroll with benefits and/or payroll in local jurisdictions like San Francisco or New York City, is complicated and subject to frequent mid-year rule changes, and it’s all too easy to overlook or getting the details wrong unless you use experienced specialists who handle a high volume of multiple paychecks.
If you are ever lucky enough to have a suitor from a public company looking to buy your business, they typically require 3 years prior SSAE16 certification from their payroll processor (What, your payroll processor doesn’t have SSAE16? Most don’t!) Not being able to produce this certification, or to do the payroll internally with uncertain accuracy, will likely void the deal as the acquiring company’s officers and directors do not want problems with their own auditors over their payroll, nor personal liability as persons responsible for possible errors on your payroll.
Don’t risk experiencing any of these problems first hand. Give your payroll the respect it deserves!