Payroll Tax Issues and Debts

Jim Buttonow, CPA CITP

Updated on: November 4, 2024

Payroll Tax Issues and Debts Facts

Four primary areas for IRS payroll tax issues

Most payroll issues involve account discrepancies (payments, deposits, W-2 v Form 941 reconciliation, amended returns), unfiled returns, audits, and unpaid balances owed. Resolving these issues can be complicated and involve dealing directly with the IRS.

Payroll audits are rare.

The IRS does not audit payroll returns often. However, all small business audits involve compliance checks, which involve a review, and potential audit of payroll tax issues. The biggest payroll tax audit issue is proper worker classification (independent contractor v. employee). The second largest issue is the proper completion and filing of payroll tax forms, including other information returns such as Forms 1099.

Unpaid payroll taxes can result in serious IRS enforcement issues.

Unpaid payroll taxes usually result in local IRS enforcement from IRS collection (a “revenue officer”). The IRS looks for rapid collection enforcement by levies and liens on most unpaid payroll taxes because most of the debt is usually from funds withheld from employees (trust fund taxes). Significant and repeated unpaid payroll tax obligations can result in criminal prosecution.

Business responsible persons can be forced to pay unpaid payroll taxes for the business.

This is call the “trust fund recovery penalty.” The TFRP can be assessed and collected for any unpaid trust fund taxes (employee withholdings) to any “responsible person.”

Payroll Tax Issues and Debts Solutions

Audits

Payroll and business audits are usually conducted by IRS field auditors (revenue agents). These audits can take up to 2 years to complete. Audits require representation before the IRS and to work with the IRS during the audit process, including any appeal. The goal of the audit is to owe the least amount of additional taxes and penaltes. A secondary goal is to complete the audit quickly and effectively. This requires extensive preparation of the books and records that will be reviewed in the audit as well as reconciling income and expenses to the return(s) in question. For employers, this will also include a review of the status of each worker paid (independent contractors) for purposes of determining their correct status (employee or contractor).

Tax Debt

Payroll and business taxpayers have alternatives to full payment, including payment plans, extensions to pay, and hardship options (not collectible status and offer in compromise). Payroll taxpayers who have unpaid payroll taxes that include trust fund taxes (i.e., employee withholdings) will likely have to undergo a trust fund recovery penalty investigation and assessment to the responsible persons. Most payroll and business tax debt issues are resolved by working directly with IRS field collection – or revenue officers.

Account Issues

There are many different types of account issues related to payroll and business taxpayers. Reconciling the discrepancy against the business and the IRS’’ records and responding until the correction is completed is the most likely solution to account issues for payroll and businesses. This may involve working with IRS accounts management or even petitioning the Taxpayer Advocate Service for resolution.

Appeals

If the IRS disagrees with the CP2000 response and the taxpayer timely requested an appeal, the taxpayer can request an IRS appeals officer to review the disagreement.

Offer in Compromise: Doubt as to Liability

Taxpayers can request that the IRS formally reconsider the CP2000 through an Offer in compromise- doubt as to liability (Form 656-L). This request is very similar to a CP2000 reconsideration request.

Resolving a CP2000 requires completing these steps:

1. 1. Review the CP2000 letter: Analyze the year and items that the IRS says were omitted. Many times, taxpayers find that information statements were filed incorrectly or that someone was using their SSN for employment.
  2. Gather your original tax return documents for the year in question: Gather the tax file for the CP2000 year in question.
  3. Compare the missing information statements on the CP2000 to your version: Review the accuracy of IRS information returns reported on the CP2000.
  4. Do your own matching: Taxpayers may want to get their IRS wage and income transcript for the year and match the information statements to the return. This reconciliation will identify any discrepancies. Now you can gather other information to prepare a corrected return if needed.
  5. If you disagree with the tax, prepare a corrected return and supporting schedules/documents: The corrected return can be used with your response. The corrected return will compute the correct tax and allow for deductions.
  6. If you disagree with the penalty, prepare your position on why you disagree: Protest the penalties by providing the IRS reasons why you made a reasonable attempt to report all items correctly on the return. Reliance on a tax pro and tax software, lack of information returns needed to file, and ignorance of the tax law are common arguments against the accuracy penalty.
  7. If you agree with the adjustment, respond to the IRS with your agreement and payment method: Use the response form and, if a payment plan is needed, a Form 9465 to request an installment agreement. Also, the taxpayer can make full payment with the response form agreeing to the assessment.
  8. If you disagree in whole or in part, prepare your complete response and send to the IRS: Respond using a cover letter explaining the disagreement(s), the CP2000 response form, documents that support your disagreement, and a copy of the original and corrected returns. In this response, the taxpayer should always request an appeal if the IRS disagrees with the response.
  9. Monitor notices for status, agreement, and assessment (if applicable): The IRS is likely to request more time if they cannot reply to your response within 30 days. IF there are more questions, the IRS can issue another CP2000. If the IRS agrees, they will send an adjustment notice or a CP2005 no-change notice (whichever is applicable). Taxpayers can also call the IRS to get a status update (be prepared for long wait times) if they do not hear from the IRS within 30 days.
  10. Appeal any disagreement: If the IRS disagrees with the response and the taxpayer timely appeals, the taxpayer can receive an appeal hearing to review their case.

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