A business with employees must pay taxes related to Social Security and Medicare. The Social Security tax consists of 12.4 percent of employee wages, up to a certain ceiling, while the Medicare tax consists of 2.9 percent of employee wages. If an employee earns more than $200,000 in a year (or $250,000 if they are married), the employer will need to pay an additional 0.9 percent tax for Medicare. These taxes are divided equally between the employee and their employer. The employer withholds half of the required amount from each employee’s paychecks, while footing the rest of the bill on their own. The employer also must file Form 941 to report withholdings from employee paychecks.
Employers often abuse this process, which can expose a business and its owners to severe consequences. The IRS and related government agencies aggressively pursue businesses that fail to keep up with their employment taxes. Business owners may face harsh fines and even jail time, and the business may not survive the penalties. Despite the risks, many employers continue to evade their obligation to pay employment taxes. They may not take the IRS seriously, they may object to paying federal taxes, or they may use the employment taxes withheld from employee paychecks as a “loan” that they plan to pay back in the future. If you are an employee, you should make sure to alert the IRS to any suspected fraud related to employment taxes.
Common Forms of Employment Tax Evasion
In the most egregious situations, a business owner may simply steal the money being withheld. This is known as pyramiding, which is when the business collects the taxes that it withholds from paychecks but retains the money rather than paying it to the IRS or another designated financial institution on a monthly or biweekly basis, as required. Business owners who engage in pyramiding often try to dodge the IRS and other creditors by repeatedly filing for bankruptcy. This allows them to start over with a new business and begin exploiting new employees.
Since an employer needs to pay employment taxes only for employees, rather than for independent contractors, many employers succumb to the temptation of misclassifying an employee as an independent contractor. The tax laws in this area can be complex, and some misclassifications are honest mistakes. Generally, though, a worker is an employee if the business controls the work that they do and the way in which they do it. (Read more here about the difference between employees and independent contractors.) An employer that misclassifies a worker will need to pay all of the overdue employment taxes in addition to monetary penalties.
A business also may falsify employee wages on a payroll tax return to reduce their tax obligation, or they may simply fail to file a return. Some businesses pay their employees in cash in an effort to more easily falsify their tax records. A business is free to pay employees in cash, but this does not affect its tax obligation. However, very little evidence exists in these situations that might alert employees or the IRS to the shortfall.