This account is known as a Trust Account. The purpose of this account is to not co-mingle payroll with an operating account. Payroll accounts contain both the amounts withheld from an employee’s paycheck and the matching amounts from the business. A Trust Account means that the money withheld from an employee’s paycheck is held in trust so that the funds will be paid out to the various taxing agencies.

The money an employee has taken out of the paycheck for taxes is not an expense to the business. The business withheld the money for future payment to the state and federal governments. Here’s an example:

John Doe has gross wages of $1,500. From the gross wages, $150 is withheld for federal taxes, $75 for state taxes and $114.75 for Social Security and Medicare. A total of $339.75 should be placed in the Trust Account, along with the employer’s portion of the Social Security and Medicare, which amounts to $114.75 for the wages John Doe earned.

When it is time to report the business payroll, whether quarterly or annually, the business must send $379.50 to the IRS and $75 to the state.

One of the most common errors with small businesses is that the business does not have a separate account for payroll liabilities, and when it is time for payroll taxes to be paid, the business does not have the money available to send to the agencies. The IRS does not consider any hardship the company may be having when failing to pay payroll taxes because the money was withheld from the employee’s paycheck. It is not the company’s money to spend on other expenses.

Another mistake small businesses make is deducting the entire amount of payroll taxes paid on the business income tax return. Amounts taken out of an employee’s paycheck are not deductible on the business return, as these were not the business’s expenses. The only expense the business had was its portion of Social Security and Medicare paid on behalf of the business.

In the above example, the business portion of the payroll taxes was only $114.75. The business may also deduct state and federal unemployment taxes paid, as these are expenses the business pays for having employees.

Failing to pay payroll taxes carries a large penalty. If you are a corporate officer or other “responsible party,” as defined by the IRS, you may be personally liable for payroll taxes not reported or deposited as required. The Trust Fund Recovery Penalty is the full amount of the unpaid tax.

So, for the above example, the TFRP is $379.50. This example is for one employee; think how large it would be if there were 10 employees. Having a separate Trust Account for payroll is a safe way to ensure that the money for payroll taxes is available when it is time to pay the tax.

Tracy Bunner is an enrolled agent and tax preparer with an office in Harrisville. She can be reached at 801-686-1995 or at tracystaxservice@yahoo.com.