Article
11 min read
What Are Unpaid Payroll Tax Penalties: Everything Employers Must Know
Global payroll
Author
Shannon Ongaro
Published
September 04, 2024
Last Update
September 30, 2024
Table of Contents
What are payroll tax penalties?
Different types of payroll tax penalties
How do international payroll tax penalties work?
What happens if payroll tax penalties go unpaid?
The top causes of payroll tax errors
How to reduce your risk of payroll tax penalties
Stay one step ahead of international payroll compliance with Deel
Key takeaways
- Unpaid payroll tax penalties can have a serious, long-lasting impact on your company.
- Organizations can eliminate the risk of penalties altogether by refining their payroll strategy. Automating and centralizing your system significantly reduces the errors that lead to compliance issues.
- Partnering with a leading payroll provider like Deel can enhance your compliance management, lowering the risk of penalties.
Payroll taxes are the contributions you and your employees make towards government programs like social security and healthcare. As the employer, you’re responsible for withholding the correct amount from your team’s wages and making the payments.
The laws concerning payroll taxes vary between jurisdictions. However, most tax authorities apply penalties if companies fail to pay the correct amount on time.
It’s crucial to handle these fees as soon as possible. Unpaid tax penalties can lead to further fines, reduced credit ratings, and damage to your company’s reputation.
Our guide looks at unpaid payroll tax penalties and how they happen. We explore how to eliminate the risk of unresolved fees, legal action, and other harmful compliance issues.
What are payroll tax penalties?
Payroll tax penalties are fines imposed by local authorities on employers who fail to meet the following obligations:
- Withholding employee payroll deductions
- Paying employer contributions
- Filing payroll reports and tax returns
- Making payroll tax deposits by due dates
- Maintaining accurate records
These penalties are designed to ensure timely and accurate tax payments. They also ensure corporations give workers the wages they’re entitled to and contribute toward the local economy.
Local governments tend to strictly enforce these penalties as the payments go towards essential services and welfare. In fact, labor taxes are usually a significant portion of most countries’ revenue. The authorities will pursue defaulting companies and take extra steps to recover the unpaid penalties.
A look at US payroll
The US is a well-known example of a country with complex and stringent tax laws.
Employers and workers must contribute social security and Medicare taxes under the Federal Insurance Contribution Act (FICA). Citizens are subject to worldwide taxation so they owe FICA taxes no matter where they work.
US corporations are required to file comprehensive reports including:
- Form 940 on federal unemployment tax payments
- Form 941 for the quarterly tax returns
- Form W-2 is an annual statement on employee wages and tax
- Any forms for their state or county
Form 941 is due by the final day of each quarter—April 30, July 31, October 31, and January 31.
Determining when to pay the taxes is more complex. The due dates depend on the total tax you’ve paid over the past 12 months. However, most employers end up following a semi-weekly or monthly schedule.
If companies fail to deposit, they start accruing interest on the amount owed. The rate rises from 2% to 10% after two weeks. The rate caps at 15% if you still haven’t settled your debts 15 days after the first IRS notice.
Want a closer look? Download our Guide to Running US Payroll.
Deel Global Payroll
Different types of payroll tax penalties
Here’s a list of the possible infractions that can incur payroll tax penalties:
- Depositing payroll taxes after the set tax filing deadlines
- Paying less than the amount owed
- Withholding the incorrect percentage from wages
- Failing to report on payroll taxes
- Submitting incomplete or inaccurate tax forms
- Maintaining incomplete or inaccurate payroll records
- Misleading employees about their rights and responsibilities
- Misclassifying workers as independent contractors
- Failing to report new hires
- Refusing to engage with the tax authorities
Penalties vary based on the size and type of the infraction, as well as the circumstances surrounding the company's actions.
For example, Australia waives the fee for late payment if it’s your first offense. They may defer the deadline and set up a payment plan for businesses in financial difficulty provided they contact the authorities ahead of the due date.
Governments typically charge a percentage of what you owe for late or missing payments. The fee helps them recoup their losses from the interest. The percentage starts around 1-3% of the total amount owed and increases if you continue to withhold tax payments.
Other types of infractions tend to incur a one-off penalty. For instance, you can expect to pay a $60 fee for each late or incorrect return in the US.
Employee misclassification cases have the most severe consequences. You must pay a penalty and any taxes you’ve accrued while the employee has been working for you as an independent contractor. Some cases have led to a prison sentence.
The penalty is per employee and has no upper limit. If you misclassify hundreds of workers, the fee can add up and stretch into the millions. For example, in July 2024, a Dallas-area company was fined more than $1.5 million in back wages and damages for misclassifying employees as independent contractors.
How do international payroll tax penalties work?
Multinational companies must comply with payroll tax laws in every country where they hire workers. You’re responsible for researching and staying updated with all the relevant local policies. If your team fails to meet their obligations due to an oversight, the authorities still hold your business accountable.
Some countries impose extra obligations on foreign corporations. For instance, the IRS requires you to report any assets that might be subject to withholding under the Foreign Account Tax Compliance Act (FATCA). This applies to any bank accounts you use to run payroll or administer benefits for your US-based teams.
Maintaining compliance with these various obligations can be challenging for large, international teams. While payroll laws tend to be similar across jurisdictions, the fine details are often different.
Social security is an example of how the laws can vary. In the US, both employers and their workers pay a fixed rate of 6.2% on all wages. Many EU countries have a more complex, tiered system based on the employee’s annual salary.
The UK is noteworthy for having one of the most intricate systems. Your insurance contributions depend on how much employees earn on a sliding scale above a set threshold.
What happens if payroll tax penalties go unpaid?
There can be severe consequences for failure to settle unpaid payroll tax penalties. Local authorities have been known to:
- Impose additional fines and interest
- Seize business assets
- Freeze company bank accounts
- Initiate legal action
- Revoke business licenses
- Report misdemeanors to credit agencies
Severe and repeated infractions can lead to jail time. In one case, a US business owner failed to pay over $2 million in payroll taxes over four years. They received an 18-month suspended sentence with no parole as well as a further $1.8 million in fees.
Besides the negative financial impact, unpaid payroll taxes can have a detrimental effect on employees. They may have to deal with complications if tax authorities garnish their wages or cause delays to benefits. Even if it’s just extra paperwork, they’re likely to feel stressed.
However, unpaid tax penalties don’t need to directly impact employees to cause them stress. 47% of the global workforce are already concerned about the stability of their job. Learning that their employer has unpaid taxes may cause more worry about their company’s future.
If you incur a penalty due to an oversight, you may not face legal action. However, the amount owed can quickly increase. It’s best to settle any unpaid taxes and fees as soon as possible to avoid serious financial ramifications.
Continuous Compliance™
The top causes of payroll tax errors
When penalties are due to oversight, it may be due to one of several causes. Understanding these causes can help you identify and fix any underlying issues with your payroll process.
- Errors in manual data entry: Many global organizations still use spreadsheets to manage payroll but these are highly error-prone. Finance teams may input the wrong amount or interpret the data incorrectly
- Skills gaps: If you don’t have a dedicated payroll team, the people managing the process may lack the relevant expertise
- Outdated knowledge resources: Many countries update their tax laws every year. Teams can easily miss these announcements and mistakenly follow the old process
- Inadequate technology: Some payroll software can’t handle high volumes of data and transfers. They can glitch, leading to data loss and delayed transactions
- Decentralized systems: Relying on several systems to handle payroll across different countries can cause inconsistencies. For example, data might get incorrectly reformatted during transfers
- Inadequate records: Maintaining accurate payroll records for a growing international workforce may become challenging. You might not even realize that specific nationalities need a certain tax form until it’s too late
- Challenging legal systems: Some countries have very convoluted tax systems. Without the right tools and expertise, payroll teams may struggle to understand all their company’s obligations
- Overlooking fringe benefits: Any benefits you award employees are likely taxable and you must account for them in deductions. However, it’s easy to overlook small items like travel passes or lunch vouchers
- Confusion over classification criteria: Many jurisdictions have detailed definitions of what constitutes an employer-employee relationship. If you misunderstand and treat a freelancer like an employee, you can trigger payroll tax liabilities
How to reduce your risk of payroll tax penalties
Most jurisdictions won’t waive tax penalties as they need to be seen to take a hard stance. That’s even if the error was due to an oversight or misunderstanding.
Your best chance at avoiding tax penalties is to maintain compliance and refine payroll processes. Here are some best practices you can follow:
Get guidance with worker classification
Countries often have different criteria for employees and freelancers. When hiring contractors, get a local expert to verify their status and check your contract doesn’t trigger any liabilities. The service comes with a fee but it’s nothing compared to the penalties associated with worker misclassification.
Deel Contractor of Record can handle worker classification wherever you hire. Our team of experts can advise you whether candidates should be employees or independent contractors. Then we create a localized contract that complies with all the relevant employment laws—all available via your dashboard.
Stay current with international payroll laws
Keep updated with the latest regulations in each country where you hire. Most jurisdictions have a dedicated website for taxes that explains your rights and responsibilities as an employer. They should have translation options for instance, the relevant Japanese and Chinese websites have the button for English featured prominently at the top of the page.
If you find the local tax websites difficult to parse, consider what other resources are available. Online newspapers like the Financial Times frequently comment on new policies.
Partnering with a global payroll provider can help you guarantee your business practices align with current policy. Leading solutions like Deel handles all the research for you and send you notifications. Our new Compliance Hub feature even simplifies the updates so there’s a low risk of misinterpretation.
Ensure steady cash flow
Regularly monitor your financial health and forecast expenses to guarantee you have sufficient funds for taxes. Top accounting platforms like QuickBooks and Xero can give you a breakdown of your profits and losses over time.
It’s worth establishing a reserve fund for payroll taxes during lean periods. While you tie up money, you may save on costs in the long run. Paying all your taxes upfront means you won’t have higher fees later when all the fees and interest accrue.
Automate payments and transfers
Replace any manual processes with payroll automation. Platforms like Deel can calculate payments, schedule transfers, and generate reports with a high degree of accuracy.
While you automate payroll, you don’t lose any of your control or oversight. Teams can easily check scheduled transfers via the dashboard before they go out. If you need to make some tweaks, you can always click on individual payments and edit them.
Only 46% of organizations say they’ve fully automated their payroll systems. Implementing the software can not only spare you from penalties but also give you a strategic advantage over competitors.
Consolidate international payroll
Centralizing your payroll operations can improve efficiency and accuracy. Instead of managing disparate systems, teams can easily collaborate on one unified system.
The main benefit is that consolidated payroll is less error-prone. Everyone logs into the same platform to view and edit records no matter where they’re located. There’s less risk of data getting lost or changed as it’s passed between payroll divisions in different countries.
When choosing a single system, be sure to choose one with wide coverage like Deel Global Payroll. You don’t want your payroll provider to limit where you can establish operations and pay employees.
Outsource payroll management
Professional Employment Organizations (PEOs) can handle all HR, payroll, and benefits administration on behalf of US organizations. As part of the package, you get access to expert guidance on federal and state tax laws.
Partnering with a PEO is an especially good move if you’re a small to medium business. You can allocate fewer resources to maintaining compliance and focus more on scaling your operations.
As one of the leading US providers, Deel PEO can improve your tax situation. We help you negotiate the best deals on mandatory benefits so you can reduce your expenses and maximize your deductible income. International companies can connect our PEO service with global payroll so there are no missing links in their system.
Stay one step ahead of international payroll compliance with Deel
When payroll laws are constantly changing, international companies must get proactive about tax compliance.
Deel Global Payroll can support you as your company launches its international hiring strategy, with continous compliance monitoring to improve your payroll compliance.
Deel US payroll gets into the fine details of federal and local laws. You can safely hire across multiple states while maintaining compliance with their different and contrasting regulations.
If you require extra assistance with US payroll, consider Deel PEO. We take care of all the administration and compliance so you can focus on the day-to-day running of your company.
Book a demo with Deel to see how we can help you manage payroll tax compliance.
About the author
Shannon Ongaro is a content marketing manager and trained journalist with over a decade of experience producing content that supports franchisees, small businesses, and global enterprises. Over the years, she’s covered topics such as payroll, HR tech, workplace culture, and more. At Deel, Shannon specializes in thought leadership and global payroll content.