Summary

1. The failure to deposit penalty is assessed when a company fails to collect and transfer payroll taxes, including federal income taxes, Social Security taxes, and Medicare taxes.

2. The penalty is based on the number of days the deposit is late and can range from 2% to 15% of the unpaid amount.

3. This penalty can add up quickly, especially if it’s part of an ongoing issue with late or missed deposits.

4. The IRS also charges interest on penalties and late taxes.

5. The financial fallout from the failure to deposit penalty can be particularly painful for small or struggling businesses.

6. The IRS can also take more aggressive collection actions, such as placing a lien on business assets or seizing them, when a business has an ongoing habit of late or missed deposits.

7. In addition to the risk of a business being liable for their taxes and penalties, individuals can ultimately be held accountable for undeposited payroll taxes.

8. If you’ve incurred failure to deposit penalties, there are options that may be available to you, such as penalty abatement or an in-business trust fund express installment agreement.

9. To avoid the failure to deposit penalty in the future, you can set up a more robust system of bank accounts, automate your payroll, and ensure you have strong record-keeping procedures in place.

 

Failure to Deposit Penalty: What It Is and How to Avoid It

Business owners have complex tax obligations, and failing to meet those obligations can lead to hefty payroll tax penalties that throw a business’s financial stability into question. The failure to deposit penalty is a common issue for business owners.

Companies are required to collect certain employment taxes from employees’ paychecks and pass them along to the IRS. When you fail to do so on time, you may have to pay a failure to deposit penalty. Timely deposits are a key part of staying compliant with IRS requirements and avoiding unnecessary financial losses.

To point you in the right direction, this post outlines the essentials of the failure to deposit penalty. Contact us to get help with this penalty or other business tax concerns.

When the Failure to Deposit Penalty Applies

The failure to deposit penalty is assessed when a company fails to collect and transfer payroll taxes, including federal income taxes, Social Security taxes, and Medicare taxes.

Every business is required to deposit on a semiweekly or monthly basis—missing that deadline by even one day can lead to a penalty. The penalty is also assessed when companies fail to deposit the correct amount.

The Role of Form 941

Most businesses are required to file IRS Form 941 on a quarterly basis. This form reports the federal income taxes withheld from employees’ paychecks, as well as Social Security and Medicaid taxes. The form also requires you to report the deposits made during the quarter.

How the Failure to Deposit Penalty is Calculated

The amount of the failure to deposit penalty is dependent on how late you are with your deposit. As noted earlier, the due date for your deposit is based on your Form 941 taxes for the last four quarters. The penalties scale the longer you wait to pay:

• 1-5 calendar days: 2% of the unpaid amount
• 6-10 calendar days: 5% of the unpaid taxes
• 11-15 calendar days: 10% of the unpaid amount
• More than 10 days after the date of your first notice or the day you receive a demand for immediate payment: 15% of the unpaid taxes

This penalty can add up quickly, especially if it’s part of an ongoing issue with late or missed deposits. Consider, for example, a business struggling to cover costs each month. They borrow from their employment taxes and miss a required deposit of $3,000. They miss their next semiweekly deposit of $2,200. They now owe 2% of both amounts, totaling $104. If they stay caught up with future deposits but struggle to pay their past-due taxes, the penalties may reach 15%, or $780. This is a significant amount of money for a small or struggling business.

You also have to remember that the IRS charges interest on penalties and late taxes. As of the first quarter of 2025, the underpayment interest rate is 7%, compounding daily. This can also snowball rapidly.

Consequences of the Failure to Deposit Penalty for Businesses

Unfortunately, a missed deposit is rarely just a missed deposit. It’s often a sign of greater issues for businesses and may indicate that a business needs further assistance from a CPA or tax attorney. First, the financial fallout can be particularly painful for small or struggling businesses.

If a company is already trying to get ahead, one late deposit can quickly turn into two, three, or more missed deposits, ultimately resulting in a business that cannot catch up.

The IRS can also take more aggressive collection actions when a business has an ongoing habit of late or missed deposits. They may place a lien on business assets, significantly hindering your ability to sell assets or use them to access credit. They may also escalate to a levy – levies allow the IRS to actually seize the business’s assets.

In addition to the risk of a business being liable for their taxes and penalties, individuals can ultimately be held accountable for undeposited payroll taxes.

The IRS may send you Letter 5857 if you have a history of making late or irregular deposits, or if the agency sees any other issues with your payroll taxes. This letter requests that you schedule a phone call with an IRS rep.

Trust Fund Recovery Penalty

The Trust Fund Recovery Penalty, or TFRP, penalizes individuals that the IRS considers to be responsible for collecting and depositing payroll taxes. Depending on the business in question, the responsible parties may be business partners, employees, corporate directors, shareholders, third-party payers, or a Payroll Service Provider.

This penalty is charged when a person is aware or should have been aware of the outstanding taxes and either disregarded the law or was indifferent to it.

The penalty is equal to the unpaid amount of the tax.

How to Resolve Failure to Deposit Penalties

If you’ve incurred failure to deposit penalties and you’re unsure how to get caught up, there are options that may be available to you. However, you must remember that the penalty increases every few days, so you should take action quickly to get your tax situation back under control.

Steps to Take

First, if you’ve received a notice, start by reading it in full. The IRS includes information on the penalty being assessed and your options for disputing it. The notice should also have a number you can call if you want to speak to an IRS representative.

Next, look at your own financial records if you’re unsure about the penalty. Look for any proof that you made the deposit; if you did make the deposit, it’s possible that the IRS made an error or that you deposited it incorrectly.

Finally, determine whether or not you are able to get caught up. If you can pay in full, you should do so immediately to avoid additional interest and penalties. If not, it’s time to reach out to the IRS or a tax attorney to explore your payment options.

Relief Options

Penalty abatement is one option that may be available to you. First-time penalty abatement provides relief from penalties for taxpayers who have a history of complying with IRS regulations and have no recent history of tax penalties.

If you have tax penalties in your recent past, don’t give up—reasonable cause penalty abatement could be an option for you. The IRS does sometimes waive penalties if you have a reason for missing a payment, such as a serious illness or death, a natural disaster, or an emergency situation that kept you from making a deposit.

You may also qualify for an in-business trust fund express installment agreement if you owe $25,000 or less and you are able to pay the tax liability in full within 24 months. If your total amount due is between $10,000 and $25,000, you have to pay by direct debit.

Tips to Avoid the Failure to Deposit Penalty in the Future

Getting out of the cycle of late deposits and failure to deposit penalties can be tough, but once you make it out, it’s important to change your protocols and procedures to avoid future tax issues.

First, look into setting up a more robust system of bank accounts to cover your various business expenses. Keeping employment taxes in the same account that you use for payroll, vendor payments, and other expenses is very risky—it makes it far too easy to access those funds when you’re running low. Ideally, you will keep employment taxes entirely separate from every other type of business funds you keep.

Second, it may be time to automate your payroll. Payroll tax software automatically deducts the necessary amounts from employees’ paychecks and transfers the money to your account of choice. You can even automate payroll deposits to take one more task off your to-do list.

You should also ensure you have strong record-keeping procedures in place. It is crucial to document all taxes collected and paid—this keeps you ready for any audit you may face in the future or any failure to deposit penalty that is assessed in error.

This may all sound like a lot, and it can be—especially for business owners whose companies have undergone rapid growth. In the early days of your business, you may be able to do everything by yourself. But as you bring on more employees and owe more in taxes, the risk of making a mistake increases. With the help of a payroll tax specialist, CPA, or another tax pro, you can streamline your deposits and avoid unnecessary penalties.

Finally, know that this advice only works if your business is staying afloat enough to cover expenses without borrowing from payroll taxes. If you end up with a failure-to-deposit penalty because you had no other option but to borrow from payroll taxes, you must take immediate action. A business in this position is often very close to closing permanently, and should that happen, you do not want to be personally liable for tons of missed payroll tax deposits. You may want to look into ways of decreasing expenses or otherwise freeing up more money to avoid relying on payroll taxes.

Payroll tax compliance is a non-negotiable when you’re running a business. Staying on top of your deposits can help you prevent financial losses and disruptions to your business operations. Working with a CPA or tax attorney can put you on the path to current and future compliance while helping you set up systems that automate your deposits.

If you’re ready to address your penalties and explore payment options, let’s talk. Call Timothy S. Hart Law Group at 518-213-3445 or contact us online now.