Federal Employment Taxes: Penalties and Interest (Part 2)

Employers that pay wages and other forms of compensation to their employees must comply with federal tax return filing and payment/deposit requirement. Employers that receive services from non-employee contractors and which make payments to these contractors must also separately report these payments.  The IRS imposes penalties on employers who fail to timely meet their filing requirements, as well as penalties and interest for not making timely tax deposits and/or payments to the IRS.

  1. Penalties

Forms 941 and 940

  • Subject to limited “reasonable cause” exceptions, the failure to timely file required Forms 941 and 940 subjects a business to late filing and late payment penalties.[1] The failure to file penalty is 5% per month on the net tax amount due and is capped at 25% of this amount.[2] The failure to pay penalty is 1/2% per month and also capped at 25%.[3] If both the failure to file and failure to pay penalties are assessed, the failure to file penalty is reduced to 4.5% per month, the maximum combined penalty for the first 5 months is 5%, the failure to file penalty continues for 1/2% per month for 45 months (an additional 22.5%), and the total combined penalty is up to 47.5%.[4]
  • A penalty for failure to deposit federal employment taxes (Form 941) may also apply and, if their taxes are not deposited within 15 days of the due date, a 10% penalty applies.[5] The failure to deposit penalty is in addition to the failure to pay penalty.

Forms W-2/W-3

  • The failure by a small business employer to timely file required Forms W-2[6], and to furnish each employee with a Form W-2, will subject the employer to penalties for both.[7]
  • Subject to reasonable cause exceptions and maximum or “capped” penalty amounts,[8] Form W-2 penalties for not filing are from $50 to $260 per return, and at least $530 per return for intentionally not filing, and with additional and separate penalties for not furnishing each Form W-2 to an employee. Maximum penalties are reduced for small businesses[9], and there are penalty exceptions for small businesses that electronically file.[10]

     Form 1099

  • Form 1099 penalties are the same as W-2 penalties above.[11]

                Forms W-4/W-9 and Back-Up Withholding

  • An employer is required to secure a Form W-4[12] from each employee prior to the payment of wages. An employer is also required to secure a Form W-9[13] from contractors.
  • Employers are required to collect and withhold federal employment taxes (employment income taxes and the employee’s share of FICA) from wages paid to an employee.[14] Failure to do so by the employer subjects the employer to penalties.[15]
  • Where an employer or payor fails to secure a Form W-4 from an employee or Form W-9 from a contractor, the employer/payor must deduct and withhold “backup withholding” equal to 28% of the payments.[16]
  • Payments subject to backup withholding are treated as wages paid by an employer to an employee.[17] If a payor does not deduct and withhold the tax, ut can establish that income taxes were paid by the payee on the payment, back-up withholding is then not due from the payor, but penalties may still be independently due from the payor.[18]
  • An employer/payor can avoid backup withholding liability where the employer/payor can provide the IRS with a certification from the employee/payee that the payment is exempt from withholding or that the employee/payee has otherwise reported the income for federal tax purposes.[19]
  • An employer may reply on a Form W-4 and Form W-9 for purposes of an exemption from withholding claimed by an employee or contractor.[20]
  • An employer or payor can receive credit against its withholding liability by showing that an employee/contractor has paid tax on payments from the employer/payor.[21] The employer/payor can request a Form 4669, Statement of Payments Received, from each employee/contractor where the employee/contractor certificates that the payments were received and reported as income on the employee/contractor’s federal income tax return. The Form 4669 is transmitted to the IRS through a Form 4670 completed by the employer/payor, and which requests credit.
  1. Interest

In addition to penalties for late deposit/payment of federal employment (Form 941) and unemployment (Form 940) taxes, interest is also charged by the IRS any late-paid taxes. The applicable interest rate changes quarterly and is presently 4%.

[1] IRC § 6651(a).

[2] IRC § 6651(a)(1).

[3] IRC § 6651(a)(2).

[4] IRC § 6651(c)(1).

[5] IRC § 6656.

[6] Forms W-2 are filed with the Social Security Administration through the Form W-3 transmittal form.

[7] S. Rept. No. 99-313 (P.L. 990514), pg. 176.

[8] IRC §§ 6724(a), 6721(a).

[9] IRC § 6721(a), (d).

[10] IRC § 6724(c).

[11] Forms 1099 are filed with the Internal Revenue Service.

[12] Form W-4, Employee’s Withholding Allowance Certificate. 

[13] Form W-9, Request for Taxpayer Identification Number and Certification.

[14] IRC §3402(a)(1).

[15] IRC § 6656(a).  See also IRC § 7501(a).

[16] IRC §3406(a).

[17] IRC §3406(h)(10).

[18] IRC §3406(d); Treas. Reg. § 31.3402(d)(1).

[19] Treas. Reg. § 31.3406(h)-3(e).  Form W-9, Part II, contains a specific representation by the payee that he is not subject to backup withholding.  Corporations are exempt from the Form 1099 requirement, and also back-up withholding.  The Form W-9 requests specific information concerning whether the payee may be a corporation.

[20] Id.

[21] Kurio v. United States, 281 F.Supp. 262 (1968 DC, TX).

About the Author

Erik P. Doerring
Erik leads the firm's economic development and tax practices. He is a business lawyer, with the skills of a tax litigator. Prior to joining McNair, Erik was an attorney with the IRS Office of Chief Counsel and the U.S. Department of Justice, Tax Division.