If you manage payroll for a small business, you should know that you’re responsible for calculating and withholding federal unemployment, FICA (Social Security and Medicare), and income taxes from paychecks. But do you know what happens if you miss even one payroll tax payment? The penalties are substantial, to say the least, thanks to the Trust Fund Recovery Penalty (TFRP) Tax enacted by the US Congress in 1954. And these penalties could come out of your own pocket. The good news is, payroll software can help you avoid potential financial and legal trouble. I’m here to walk you through how.
Trust Fund Recovery Penalty (TFRP): The IRS Rule That Can Hit You Personally
When you employ workers, they assume that you’re going to get payroll right. They trust you to come through with the compensation you promised and to withhold and submit their income and FICA taxes on time and in the correct amount. That’s why the TFRP refers to payroll taxes as “trust fund taxes.” You hold your employees’ money in trust until you make federal tax deposits to the IRS.
The IRS can assess the TFRP Tax against any individual who “…is responsible for collecting or paying withheld income and employment taxes…and willfully fails to collect or pay them.” In order for willfulness to exist, the agency explains, this person must (or should) have been aware of the taxes due but intentionally ignored the legal obligation or was indifferent to it. No “evil intent or bad motive” is necessary.
Who is a responsible person? In short, it’s an individual or group whose job it is to collect, account for, and pay trust fund taxes, or to direct those activities. They might be, for example:
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A corporate director or shareholder
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A member of the board of trustees of a nonprofit organization
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A member or employee of a partnership
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An officer or an employee of a corporation
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A Payroll Service Provider (PSP) or a responsible party within a PSP
The penalty is 100% of the unpaid income taxes withheld, plus the employee’s portion of the FICA taxes withheld. You might also face Failure to Deposit penalties if you pay late, in the wrong amount, or in the wrong way. That penalty is a percentage of the taxes you didn’t deposit correctly. Keep in mind that the IRS charges interest on penalties. Obviously, you want to owe the IRS any of these fines.
Setting Up Payroll Software: Enter Every Detail to Avoid Mistakes
Before you can start setting up your software to deal with payroll taxes, you need to populate it with myriad details about your company, its employees, and the benefits you offer. Be sure to do so accurately and thoroughly. Some of this information directly ties to your payroll tax obligations; if it’s incorrect, your taxes won’t be either.
The Best Payroll Software We’ve Tested
Company Information
You start by creating an account for a service, taking advantage of all the security options it offers. It will eventually be storing a lot of sensitive information, such as bank accounts and Social Security numbers, after all. You will also see fields for:
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The business bank account you use to fund benefits, pay workers, and submit payroll taxes
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The name of the responsible party (probably you)
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Your business structure, such as sole proprietor, partnership, or LLC
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Your company’s legal name (the one the IRS uses)
Employee and Contractor Records
One of the forms you give to employees during onboarding is a W-4. The information they provide, such as their address, legal name, and Social Security number, will help you determine how much income to withhold for taxes. Employees and contractors also must complete an I-9, Employment Eligibility Verification. Payroll software requires additional details, such as birthdate, salary or hourly rate, and title. You can either enter this information yourself or invite employees to complete their records (save for some personnel data). You can always easily retrieve and edit these records as necessary.
Payroll Schedule and Earnings Types
How often will you pay employees (both salaried and hourly) and contractors? Payroll services provide multiple options and let you pay different groups of workers on different schedules. You can also set up numerous earnings types, such as bonus, commission, holiday, overtime, regular, and reimbursement. If an employee splits their time between two different positions, such as barista and hostess, you can assign different pay types to the same payroll.
Earnings and deductions in ADP Run (Credit: ADP/PCMag)
Time Off Accruals
If you offer employees paid time off, how do they earn it? Payroll software lets you set up policies for accruing sick and vacation pay, as well as generic PTO. You can base accumulation on hours worked or on a pay period, and you can distribute a lump sum. It’s also possible to set maximum annual accruals and allow hours to either roll over or expire if an employee doesn’t use them.
Other Employee Benefits
Do you offer your employees additional benefits, such as health insurance? Payroll apps have tools for choosing plans, tracking premiums, and setting up withholding benefits: dental, Family and Medical Leave Programs, HSAs and FSAs, life insurance, medical, numerous types of retirement plans, vision, workers’ comp, and more.
Some companies, such as Gusto and OnPay, act as brokers, allowing employees to shop for plans within a benefit and price range and then sign up. Or you can bring in your existing brokers and providers.
Most payroll software adapts well to mobile browsers; some offer dedicated apps (Credit: OnPay/PCMag)
Stay Compliant: Federal and State Payroll Tax Requirements
Keeping up with your payroll tax obligations requires close attention to due dates, form names and numbers, numerous tax tables, and payroll tax formulas if you process payroll manually. It’s the most complex element of payroll, and as I’ve noted, you need to do it accurately and on time.
Payroll software automates much of the payroll tax process—once you complete a bit of legwork. You have to obtain an Employer Identification Number (EIN), for one thing. You can get one for free from the IRS by applying online. Once the agency receives your request, you will get a confirmation notice in the US Mail that tells you which federal tax forms you must file (usually Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return) and Form 941, Employer’s Quarterly Federal Tax Return) and how often you submit payroll taxes (typically monthly, at least initially).
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You also have to go through state registration and set up anything that your state requires, such as a state ID and state unemployment insurance (SUTA). Every state has different payroll requirements. The IRS maintains a list of links to state websites that can provide specific information, including links to state Departments of Revenue (or similar agencies) for a state ID and for information about any local IDs that apply. Patriot Software also has a guide for business owners new to payroll, complete with links to state registration sites.
Error messages in QuickBooks Payroll (Credit: Intuit/PCMag)
Finally, it’s critical that you account for any payroll you or anyone else ran this year. Some of the payroll software providers I’ve reviewed, such as ADP Run, offer automatic import from competitors. At the very least, your new provider’s expert staff will be able to provide assistance. They can be very helpful in setting up your company. In fact, they prefer that to trying to untangle problems once you start running payroll.
Payroll software provides guidance in many areas as well. It often alerts you when you’re missing a critical step in your setup.
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Automate Payroll Taxes: Payments, Filings, and Compliance Made Easy
Besides calculating your payroll taxes, payroll software’s ability to automatically pay your taxes and submit your filing forms when they’re due is probably the single most compelling reason to use it. The apps I’ve tested calculate each employee’s gross pay and withhold the correct amounts for:
Employers, of course, are responsible for paying the employer portion of FICA taxes (FUTA and SUTA) in addition to any other obligations, such as employer-sponsored benefits and workers’ compensation insurance.
Once you run payroll, you see a breakdown of gross pay, withholdings (employer and employee), and net pay. Sometimes this information appears before you actually submit the payroll, and you can often see what employee pay stubs will look like.
Once you approve your payroll, your work is done (unless you have to print employee paychecks). Payroll software then withdraws money from your bank account for employees’ net pay direct deposits, payroll taxes for both you and your employees, employee benefit deductions and your contributions, and garnishments or other deductions. It then dispatches the funds to the correct entities. When payroll filings are due, it prepares and submits them electronically.
It’s important to find out up front how long it takes your payroll software company to withdraw the total cost of processing a payroll from your bank account. It varies, though it’s generally within a day or two. Intuit QuickBooks Payroll even offers a same-day option in two versions. You want to make sure the money will be there, of course. Your service provider will always tell you the exact day the withdrawal will take place.
Payroll overview in Patriot Software Payroll (Credit: Patriot Software/PCMag)
Payroll software uses all the data it amasses throughout the year to prepare and (sometimes) dispatch W-2 and 1099 forms. This might involve an extra charge, as can some other elements of payroll software. Before you commit to a specific payroll company, be sure you know exactly what extra fees you will have to pay. OnPay and Square Payroll are good about not tacking on additional charges.
You Pay Enough Taxes, Don’t Add IRS Penalties to the List
I can’t imagine why you would continue to do your company’s payroll manually when software that handles everything—including the dreaded payroll taxes—is readily available. Payroll services work extremely well, so long as you supply all the correct information they need and meet your payroll deadlines. You are sure to minimize your exposure to hefty IRS penalties and thorny legal complications, reduce your stress level tremendously, and save time.
Of course, you should explore these apps thoroughly before deciding on any of them, and pay special attention to any potential add-on costs. Browse their websites and call their sales lines with questions before committing.
About Our Expert
Experience
I write about money. I’ve been reviewing tax software and services as a freelancer for PCMag since 1993. Along the way, I took on reviews of other types of business and personal finance technology. Prior to that, I had spent a few years writing about productivity and entertainment applications for 8-bit personal computers (my first one was a Commodore VIC-20) as a member of the editorial staff at Compute!
After working at Lawson Associates, now Lawson Software, I switched my focus to accounting but learned that personal computer applications were more progressive and interesting to cover than mainframe solutions. So I served as editor of a monthly newsletter that provided support for accountants who were just starting to use PCs. I still ghostwrite monthly how-to columns for accounting professionals. From there, I went on to write articles and reviews for numerous business and financial publications, including Barron’s and Kiplinger’s Personal Finance Magazine.
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