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Third-party payroll services: outsourcing and tax liability

On Behalf of | Feb 25, 2015 | Tax Controversies

As the owner or operator of a small business, you face multiple pressures. Marketing your product or service effectively, driving revenue growth and managing employees are only some of the many demands on your time and attention.

Given these demands, it makes sense for many businesses to use a third-party provider to handle payroll services and tax compliance tasks. In this post, we will discuss some of the considerations to keep in mind in using such providers.


Let’s begin by acknowledging the efficiency that comes from using a third-party arrangement effectively to take care of employment tax duties. A payroll service provider can handle withholding proper amounts from employees’ paychecks and make sure funds are transferred to the IRS in a timely manner.

But what happens if a third-party provider that was supposed to pay your taxes doesn’t do it? This could happen, for example, if the provider experienced financial problems, such as bankruptcy. It could also happen in cases of fraud, where the third party makes off with money that was supposed to be used to pay your taxes.

What happens is that you, as the employer, are still responsible for paying payroll taxes, even if you have outsourced those duties to a third party. This is true even if you made the necessary funds available to the third party. If something goes wrong on their end, you may still be on the hook for the taxes that weren’t paid.

This doesn’t mean you shouldn’t use a third-party provider. But it does suggest you should choose that provider carefully.

You should also be aware that when your employees’ income and payroll taxes aren’t properly withheld and paid over to the IRS, it can trigger the Trust Fund Recovery Penalty (TFRP). We discussed the TFRP in our August 21 post last year.

Source: IRS.gov, “Outsourcing Payroll Duties


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