Payroll Provider Didn't Deposit Taxes: IRS Notice, What to Do

Who owes the payroll tax when the payroll provider didn't deposit it?

The employer owes it in nearly every outsourced setup. The IRS bills the business that owns the payroll account for the tax, penalties and interest, even when the money went to a provider that never passed it on (IRS: outsourcing payroll duties). A payroll service provider or reporting agent is not liable as the employer, or as the employer's agent, for the employer's employment taxes (Publication 15, section 16). Only a certified professional employer organization (CPEO) generally takes it over, for its worksite employees; see below.

The case is not simple when:

• more than one quarter is involved, or you cannot tell which quarters were deposited;
• the provider (a payroll company, service or software) also skipped the quarterly returns, closed, or stopped answering;
• the provider only calculated payroll and left the payments to you, or your books show the tax as paid while the IRS account shows a balance;
• IRS letters went to an address you do not read;
• the unpaid amount includes tax withheld from employees, which can reach individuals.

Gather before you call the IRS: bank statements showing each payroll-tax draft, any payment confirmations with EFT trace numbers, the provider's tax reports and service agreement (download them while you still have access), your IRS payment history and transcripts, and every IRS notice with its date. This page covers federal payroll tax only. State payroll and unemployment accounts can have the same gap; see behind on payroll taxes.

What should I do first when the IRS sends a bill or notice?

Contact the IRS and say a payroll provider is involved; do not wait for the provider. The IRS tells employers to call the number on the bill, write to the office that sent it, or call 800-829-4933 (IRS: outsourcing payroll duties). In this order:

1. Note the response date on the notice. For what the notice means, see an IRS notice to your business.
2. Ask the IRS for the account by quarter: returns filed, payments posted, penalties assessed. A representative can see your account with Form 8821, or speak and act for you with Form 2848.
3. Pay tax confirmed to be unpaid after reconciling the payment records. If a payment confirmation shows money sent to the IRS that is missing from the quarter, contact the IRS with the confirmation or EFT trace number to locate it and correct where it was applied (Publication 15). Pay the rest from your own account. Paying stops further penalties and interest on that amount (IRS: failure to deposit penalty), and an amount still unpaid more than 10 days after the first notice moves to the 15% deposit penalty rate.
4. Keep your own address on file with the IRS. The IRS warns that pointing it to the provider can leave you unaware of tax matters.
5. If withheld tax is still unpaid, see the personal liability section below, which covers what the IRS looks at when other creditors are paid first.

How do I prove what the provider deposited and what it did not?

First confirm the arrangement. A payroll service provider or reporting agent files and deposits under your employer ID number. An approved section 3504 agent or a CPEO files aggregate returns and deposits under its own, so a missing return or deposit under yours alone does not show a failure. Get its confirmations, and ask the IRS how your account treats them before you file again (IRS: third party arrangement chart; IRS: CPEO customers).

Then compare three records for each quarter: what left your bank, what the IRS received, and what the IRS posted to your account.

EFTPS keeps over a year of payment history online; for older payments use the account transcript. If the provider enrolled you, you hold an Inquiry PIN for checking deposits; activate it (Publication 15). A business tax account also shows IRS notices; an LLC that files as a sole proprietor cannot use one yet and relies on EFTPS and its IRS letters (IRS: business tax account).

Build one row per quarter: tax shown on the payroll reports, amount drawn from your bank, amount the IRS credited and on what date, and whether the return was filed. A gap between the first and third columns points to unpaid tax, and the dates in the third column drive the penalties.

Did the provider skip the quarterly returns, or only the deposits?

Check both; they are different failures with different penalties. The account transcript shows whether a Form 941 posted for each quarter and what payments posted against it.

The failure-to-deposit rate depends on how late the money reached the IRS. The rates do not add together.

The late-return and late-payment rates come from Publication 15. In a month when both apply, the late-return penalty is reduced by the late-payment penalty. The late-payment rate rises to 1% a month starting 10 days after a notice of intent to levy, or sooner on a demand for immediate payment (26 U.S.C. 6651(d)). Interest also runs on the tax and on penalties until paid.

A third failure is notices that never reached you. The IRS writes to the address it has on file; if that was changed to the provider's, update it with Form 8822-B (Publication 15). Annual Form 940 and Forms W-2 can be missing too: see behind on payroll taxes and late W-2 and 1099 forms.

Can the IRS remove the penalties because the provider failed?

Sometimes, but the provider's failure alone is generally not the reason. The IRS says relying on a tax professional is generally not a valid reason, and its internal manual (guidance for IRS staff, not law) says the duty to make deposits cannot be delegated (IRS: reasonable cause; IRS manual, 20.1.1). The manual also says relief for a payroll processor's delay is not available, a matter between the processor and its client under their contract (IRS manual, 20.1.4).

Three routes remain:

The first two look at your account history, not at who caused the failure. They need:

• the same return filed on time for each of the prior 3 years (12 quarters), unless IRS records show no filing requirement for a period; a return the IRS prepared for you does not count;
• no penalty charged in those years, or one later removed for reasonable cause or IRS error;
• for employment tax returns, fewer than four deposit-penalty waivers in that period, and a penalty not caused by avoiding EFTPS.

Automatic relief also needs the original return filed within 3 years of its due date (IRS: administrative penalty relief; IRS procedural update). A quarter that already received relief this way does not count as a clean quarter later, so it generally reaches one quarter in a run of missed ones. How to ask: see behind on payroll taxes.

Reasonable cause turns on facts: ordinary business care and prudence, compliance history, how soon you fixed the problem, and whether the cause was beyond your control (IRS manual, 20.1.1). Useful facts: when the money left your bank, how you monitored the provider, when you learned of the failure, and how fast you deposited or filed afterward. The statement must address each penalized deposit by amount and date, or the IRS treats no valid reason as shown. Where the provider moved the money from your account on time but sent it late, the manual does tell examiners to run a reasonable-cause review (IRS manual, 20.1.4). Neither is a promise of relief.

To ask, call the number on the notice with the notice, the penalty and your reasons. A removed penalty takes its interest with it, but not the tax or the interest on the tax (IRS: reasonable cause). If you already paid the penalty, a refund claim on Form 843 generally must be filed within 3 years of filing the return or 2 years of paying, whichever is later (IRS: Form 843 instructions).

How do I correct the account and pay what is owed?

Fix the filings and pay the tax first, because a relief request rests on a correct account. In order:

1. File what is missing. File any quarter's Form 941 that was never filed under your number. Use Form 941-X to correct wages or tax on a filed return. If only the liability dates or amounts (Part 2 or Schedule B) are wrong, do not file Form 941-X for that; an amended Schedule B can reduce a deposit penalty (IRS: Form 941-X instructions; IRS: Schedule B instructions). If the return is right and only the deposits are missing, nothing is amended: the tax is paid.
2. Pay from your own account through your business tax account, EFTPS or Direct Pay, which are free (IRS: depositing and reporting employment taxes). The IRS generally applies a deposit to the most recent liability in the quarter first. After a deposit-penalty notice you can designate how deposits apply within 90 days of the notice (Publication 15).
3. If you cannot pay it all, pay what you can and apply for a payment plan; see payment plans for business tax debt. A partial payment with no written instruction generally goes first to the employer's share. A voluntary payment can be designated in writing, when you pay and for named periods, to the withheld tax (IRM 5.7.4).
4. Match the books to the IRS account. Books built from a provider's reports can show tax as paid that the IRS never received. Reconcile the payroll tax liability by quarter; see payroll liabilities that won't clear and payroll journal entries.
5. Ask for penalty relief as above.

Can I report the payroll provider, and what does the IRS do with the complaint?

Yes. File Form 14157, the return preparer complaint. It has a Payroll Service Provider status and an Employment Taxes complaint for a provider that did not remit employment tax in full or on time, or did not prepare returns accurately or on time. Attach the service agreement; send no original returns or payments. The form says to submit online at IRS.gov/SubmitATip, and the IRS says provider complaints get expedited handling and investigation (IRS: outsourcing payroll and third-party payers).

The complaint does not fix your account. Answer the notice or call 800-829-4933 (IRS: tax return preparer misconduct). Getting money back from the provider is a contract matter, outside the IRS.

Is a professional employer organization different from a payroll service?

Yes. The difference is who is liable. A certified professional employer organization (CPEO) agrees by contract to take over some or all of your federal employment tax duties, and only a certified one moves liability off you, generally only for its worksite employees (IRS: third party arrangement chart; IRS: CPEO customers).

A professional employer organization that is not on the IRS list of certified ones is outside the CPEO rule, so do not assume it carries the liability (IRS: CPEO customers; 26 U.S.C. 3511).

Am I personally liable for the unpaid tax?

It depends on how the business is organized and who controlled the money. Individuals can be reached in two ways.

As the employer. A sole proprietor owes employment tax personally. A single-member LLC is a separate entity for employment tax, so the LLC owes, not the owner directly. General partners generally owe a partnership's debts under state law, and a limited liability partnership can differ (IRS manual, 5.17.7; IRS: single member LLCs).

Under the trust fund recovery penalty. If the IRS cannot immediately collect unpaid withheld tax from the business, a responsible person who willfully fails to collect or pay it can owe 100% of the unpaid trust fund tax (26 U.S.C. 6672): the withheld income tax plus the employees' share of Social Security and Medicare. The employer's own share is not part of it. The IRS lists the payroll provider and its responsible people among those who can be responsible (IRS: trust fund recovery penalty). Who counts as responsible and what willful means are in the trust fund recovery penalty.

For an owner who learns the provider did not deposit, what happens next matters most. Using available money to pay other creditors when the business cannot pay the tax is an indication of willfulness, and Notice 784 counts paying net payroll instead of the tax (IRS: Notice 784). The IRS proposes the penalty by letter. You have 60 days from the letter's date to appeal, or 75 days if it is addressed outside the United States. After assessment it can file a lien or levy personal assets. It generally has 3 years from April 15 of the next year, or from the filing date if later, to assess it, and no time limit while the return for a period is unfiled (IRM 5.7.3).

How do I check deposits myself from now on?

Check them yourself; do not rely on the provider's report.

1. Enroll in EFTPS under your own employer ID number, or use your business tax account. Activate the Inquiry PIN if the provider enrolled you.
2. After each payroll, confirm a payment for the right amount by the deposit due date. The IRS calls the first missed or late payment a red flag (IRS: outsourcing payroll duties).
3. Before each Form 941 is filed, compare its total taxes after adjustments and nonrefundable credits (line 12) with its total deposits for the quarter (line 13), which can include an overpayment applied from an earlier quarter, and with your IRS payment history; check that its liability dates (Part 2 or Schedule B) match your pay dates (IRS: Form 941 instructions; IRS: Schedule B instructions).
4. With a certified professional employer organization (CPEO), deposits go under the CPEO's number and its customers cannot see them in EFTPS; ask the CPEO for proof (IRS: CPEO customers).

When you move to a new provider, see switching payroll providers.

Example

These examples are illustrative; amounts are in US dollars.

Two quarters of drafts, no deposits

A restaurant LLC's payroll company drew $9,000 a quarter for tax from its bank account but deposited nothing for two quarters. The IRS bills $18,000 plus penalties. The bank drafts prove the money left; only the IRS account shows whether any of it arrived, and the LLC owes whatever is unpaid. Suppose $6,000 of each quarter's $9,000 was withheld from employees. If the LLC cannot pay, the IRS can assess the trust fund recovery penalty against a person it finds responsible and willful; the amount is measured by the withheld part, $12,000. The employer's share, $6,000, stays with the LLC.

A subscription that lapsed

A small firm's payroll subscription lapsed in March, and the owner believed taxes were still being filed. The second-quarter return and deposits never happened. The firm files the missing return, deposits the tax from its own account, and asks for penalty relief. The IRS generally does not accept reliance on someone else to file and deposit as reasonable cause, so relief may depend on the firm's record for the prior three years, if it qualifies for the administrative routes at all.

A deposit made 20 days late

A $6,000 deposit reaches the IRS 20 days late. That is more than 15 days, so the failure-to-deposit penalty is 10%, or $600, plus interest. The firm asks for relief by phone, or on Form 843 with the dates in writing, and attaches the bank statement showing when the money left its account.

Different for you?

• The IRS billed you for tax a provider was to pay, you cannot tell which quarters were deposited, or more than one quarter is involved: what was paid and owed in each quarter, and whether to ask for penalty relief and on what grounds, turn on records rebuilt quarter by quarter. See bookkeeping help.
• Your books show the payroll tax as paid but the IRS shows a balance, or the provider closed and left no reports: each quarter has to be rebuilt from bank statements and IRS transcripts, not from the provider's reports. See bookkeeping help and payroll liabilities that won't clear.
• A revenue officer wants to meet, or the IRS proposes a personal penalty: see the trust fund recovery penalty.
• The balance is more than the business can pay: see payment plans for business tax debt.
• You missed deposits or returns for reasons beyond the provider: see behind on payroll taxes.
• Your own bookkeeper or accountant caused the penalty: see bookkeeper mistakes and penalties.
• A payroll run itself was wrong: see fixing a payroll mistake.