Businesses evolve over time, and business owners may eventually need to make changes to their payroll tax accounts. Whether they are hiring new employees, expanding into new states, changing their business structure, or closing their business altogether, a mid-year review of your clients’ payroll tax accounts can ensure they are in compliance.
Failing to maintain current payroll tax accounts can create significant compliance issues for business owners. For example, failing to open payroll tax accounts for employees can result in penalties and interest, and failing to close accounts can mean penalties for missing tax returns.
For accounting professionals, understanding when and how to open, change, and close payroll tax accounts for your clients can help avoid costly mistakes.
When to Open Payroll Tax Accounts
Before a business can legally pay an employee, they must establish payroll tax accounts with the appropriate federal and state agencies. These registrations allow employers to withhold and remit applicable payroll taxes and comply with federal and state tax requirements.
New payroll tax accounts are also required when a business hires employees in a new state. They may also be required when changing a business entity type if the change results in a new legal entity or requires a new EIN under IRS rules. They may also be needed when a new business is purchased, as payroll tax accounts typically do not transfer to the new owner.
A payroll tax account may also be required when an LLC or corporation elects S corporation taxation status. Under this election, shareholder-employees who do substantial work for the business must be paid a reasonable salary through payroll. Income taxes, Social Security, and Medicare taxes must be withheld, just as they would be with any other employee.
How to Open Payroll Tax Accounts
The first step in opening a payroll tax account is to obtain an Employer Identification Number (EIN), which is necessary to report employee wages and payroll taxes, file federal payroll tax returns, make federal tax deposits, and issue W-2 forms.
The next step is to register for state payroll tax accounts, including state income tax withholding accounts (in states that collect income tax) and state unemployment insurance (SUI) accounts. Some jurisdictions also require other local tax registrations.
Most payroll tax accounts generally require the legal business name, EIN, business address, entity type, responsible party information, date wages will first be paid, the estimated number of employees, and the industry classification (NAICS) code. Ideally, these accounts should be established before the first payroll is processed.
When and How to Change Payroll Tax Accounts
There are several situations in which a business may need to update its payroll tax accounts, such as business name or address changes, changes to responsible parties or officers, changes in entity classification, and expansion into new states.
To update federal records, use Form 8822-B to report changes to the responsible party or business address, update information on applicable tax returns, or follow other IRS procedures applicable to the specific change. The process of updating state records varies state to state, but most have online portals for simple changes. Payroll provider services should also be notified of any changes.
As a reminder, new payroll tax accounts are usually required for business sales, mergers, formation of a new entity, entity conversion, and any situation requiring a new EIN.
When to Close Payroll Accounts
The most common reason why a business would need to close its payroll tax account is that they are closing the business. But other situations also call for payroll tax account closure, including selling the business, changing to a new business entity that requires a new EIN, or no longer having employees.
How to Close Payroll Tax Accounts
An EIN generally remains assigned to a business permanently. However, if the business closes, the IRS should be notified with the business name, address, EIN, reason for closure, and the date operations ended. The IRS will update its records to reflect that no future employment tax returns are expected.
Final tax returns should be filed and all outstanding tax liabilities paid. When submitting the final return, it is essential to check the “final return” check box. Employers should make any remaining federal tax deposits and ensure all employment tax liabilities are fully satisfied before closing payroll accounts.
Use the following forms and be sure to include the date the final wages were paid:
- Form 941, Employer’s Quarterly Federal Tax Return
- Form 944, Employer’s Annual Federal Tax Return (if applicable)
- Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return
Part of the closure process includes issuing final wage statements. This entails issuing final W-2 forms to employees, filing W-2 and W-3 forms with the Social Security Administration, and filing any 1099-NEC forms for independent contractors.
How to Close State Payroll Accounts
Closing state payroll tax accounts is often more complex. The process varies from state to state, but most states require separate closure requests for state income tax withholding accounts, state unemployment insurance (SUI) accounts, and local payroll tax accounts, if applicable. Although the specific requirements vary, employers must typically provide the date wages were last paid, the reason for the closure, confirmation that all final payroll returns have been filed, and confirmation that all tax liabilities have been settled.
Retaining Employee Records
The IRS generally requires employers to retain employment tax records for at least four years after the date the tax becomes due or is paid, whichever is later. It’s important to advise your clients on this requirement.
Keeping Payroll Tax Accounts Updated: More Than a Formality
Opening, updating, and closing payroll tax accounts for clients may seem like a basic administrative task, but it plays a critical role in maintaining compliance. A missed registration can lead to penalties and interest, while failing to close an account can trigger notices for unfiled returns. By conducting mid-year reviews, accounting professionals can help their clients remain compliant and avoid costly mistakes.
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Nellie Akalp is a passionate entrepreneur, recognized business expert and mother of four. She is the CEO of CorpNet.com, the smartest way to start a business, register for payroll taxes, and maintain business compliance across the United States. Loved by entrepreneurs, accountants and lawyers, CorpNet offers transparent pricing and a simple ordering process. Payroll service providers and larger firms appreciate CorpNet’s quickly scalable software and API solutions.
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