Tax Penalties and Interest – Revisited

It’s tax return filing deadline week for individual filers in the U.S., and I’ve talked to many frenzied folks who hurried to complete their tax returns on time. This prompted me to think about all the scenarios where things aren’t remitted to the IRS on time, including corporate payroll tax deposits.

Whether you've been in stock compensation for a short time or for years, you're likely aware of the IRS regulations that require the timely deposit of taxes withheld from employees by employers. We often hear about the fact that penalties and interest may apply when tax deposits are late, but I rarely hear discussion about the specifics of just what those penalties and interest consequences translate to in real dollars and cents. I wrote a blog about this years ago, and today I’ll resurrect some points of the past. Sometimes it's good to have a context for just how much impact practice failures can have, and I will attempt to once again define the financial consequences for missing payroll tax remittance deadlines.

I'm in Stock Admin...Do I Really Need to Care about IRS Penalties?

In short, the answer is yes. Although the stock administration function in the organization typically does not, by virtue of job description, have a direct role in remitting tax withholdings to the IRS, the function certainly can have a material impact in generating those withholdings. The most common area where stock plan activity puts payroll deposits at risk of penalties is where those transactions (either as standalone, or, in combination with the company's other tax withholdings) accumulate to a deposit liability in excess of $100,000, triggering the requirement that those dollars must be remitted to the IRS within one business day.

As a result, you should care about what happens if payroll (or whomever is tasked with interfacing with the IRS) cannot meet the deadline in a timely manner. If the stock administration function has any role in the delay, then eyes are likely to turn towards to you as potentially significant dollars are spent on penalties and interest. It's one thing to know that there are some abstract penalties involved, but when you put a quantity to it, the significance of it starts to set in.

Dollars and Sense

Here's the bottom line about what could be levied by the IRS for late tax deposits:

• Interest: Any underpayment of taxes due may trigger interest. Typically, for corporations, the amount of interest is equal to the Federal short-term interest rate plus 3%. The 3% may increase to 5% in cases where the underpayment was in excess of $100k for periods after the IRS issues a notice of proposed deficiency. I'm told that it may be possible to avoid the interest part of the consequence if any underpayment of FICA or Federal tax withholdings is corrected by the due date of the Federal Form 941 relative to the period in which the underpayment error occurred.
• Penalties: The amount of the penalty will directly correlate to just how late the taxes are deposited with the IRS. If the deposit is made within 5 days of the deadline, the penalty is 2%. For periods more than 5 days to not more than 15 days, the penalty increases to 5%. Deposits more than 15 days late are subject to a 10% penalty. The amount could potentially increase to 15% if not paid within a certain time frame after the IRS notifies the company of the penalty.

Yikes! What's a Stock Administrator to Do?

There are certain transaction types where the IRS has given directive that allows the company ample time to receive funds and make a deposit. For example, in the case of a non-qualified stock option exercise, the funds are due to the IRS within one business day of the settlement of the exercise (if a broker trade was involved, and provided the settlement occurs on a timely basis). This allows the company to actually receive the funds, and then turn around and remit them to the IRS.

For other transactions, such as those involving the vesting of restricted stock units, the taxable event for the shares is based on when the employee has constructively received the shares (Barbara Baksa wrote a detailed blog on this topic “What is the Vesting Event for RSUs”  just a couple of weeks ago.) If the company uses the vesting date for this purpose, then taxes would need to be deposited to the IRS within one business day of the vesting date (when combined withholdings for the company on that date are in excess of $100k). Since in most cases, the amount of tax due isn't actually known by the company until the date of the vest (and this may be late in the day, after the stock market closes, depending on how you define the fair market value to be used in the calculation), it's very challenging to meet the IRS's requirement for one-business day deposits of those amounts in excess of $100,000.

In considering the potential interest and penalties for failing to deposit on time, many companies have adopted the practice of estimating their tax deposits and then doing a subsequent true-up. One piece of advice: if you're going to estimate taxes due, overestimate rather than underestimate. If you overestimate and remit the payment on a timely basis, you avoid all potential penalties and interest. If you underestimate, you still may trigger penalties and interest. Estimating deposits requires cash flow planning on the part of the company, but is a proactive way to avoid getting into a penalty situation with the IRS.

The Bottom Line

In short, failure to make timely tax deposits can become a costly situation for companies, particularly when repeat offenses or overly large deposits are involved. This is not an area where a simple $50 or $100 fine is slapped per occurrence. With penalties equivalent to a direct percentage of the tax deposit amount, and with current interest rates around 6%, the dollars can add up quickly. These consequences further underscore the need for payroll and the stock plan function to have a close working relationship in ensuring tax deposits are remitted quickly and timely.