First off, the penalties for failing to file these returns are substantial. There is the failure-to-file penalty of 5% of the tax due for each month or part of the month it wasn’t reporting (up to 25% maximum). If you receive a penalty notice, you may be able to provide a reasonable cause, but reasonable cause is not the fact that you spent the money on something else (it’s called a “trust” fund for a reason).
The IRS can, and does, seize business assets, close bank accounts, and garnish accounts receivables to get what is owed.
Even more ominous is the 100% “Trust Fund Penalty”, which is applied to any “Responsible Person” such as owners, officers, or check-signers. This is personal liability, the corporate shield will not protect from the IRS’s collection activities.
Finally, of course, there is the potential for criminal prosecution for failure to file. Section 7203 of the Internal Revenue Code states:
Any person required under this title to pay any estimated tax or tax, or required by this title or by regulations made under authority thereof to make a return, keep any records, or supply any information, who willfully fails to pay such estimated tax or tax, make such return, keep such records, or supply such information, at the time or times required by law or regulations, shall, in addition to other penalties provided by law, be guilty of a misdemeanor and, upon conviction thereof, shall be fined not more than $25,000 ($100,000 in the case of a corporation), or imprisoned not more than 1 year, or both . . . .
Indeed the IRS takes failing to file the 941 return and failing to pay withholding tax to be a serious thing.
The simple advice: if you are cash-strapped, do not, under any circumstances, use employee withholdings for anything else but to pay the IRS. It is better, in the long run, to default on your rent or on your business loan than to default with the IRS.
And, if you haven’t filed, you should file the return as soon as possible to avoid the possibility of criminal prosecution. Consult with a tax professional soon so as to arrange with the IRS to an agreement to not prosecute and enter into a payment arrangement.