Introduction
There are many reasons employers don't withhold or pay employment taxes.
For some, it may be an attempt to use the government as a bank to
'borrow the money for a short while' with good intentions to pay it back
later. For others, it may be a situation where an employer collects the
taxes and elects to keep it during a period of financial difficulty
rather than pay it to the IRS. Regardless of the reason, federal law
requires employment tax withholding and payment by employers.
Employment taxes consist of federal income tax withholding along with
social security and Medicare taxes and unemployment taxes. Also, many
states have withholding requirements for various employment related
taxes, such as income taxes. In addition, any business that has
employees is liable for unemployment insurance contributions on at least
a portion of the wages. Improper reporting or payment of employment
taxes affects the ease with which employees can claim future benefits
from these programs.
The IRS takes a variety of steps to combat employment tax
non-compliance. The agency has a number of civil actions it can take
like audits and filing tax liens against property the taxpayer owns. In
addition to civil actions, IRS Criminal Investigation investigates and
refers for prosecution individuals and businesses that have willfully
attempted to avoid filing and paying employment taxes. These efforts
have led to significant criminal convictions resulting in incarceration
and fines.
Prison time is not unusual, for both federal and state violations. In
many cases the taxpayer is still required to make restitution.
Eight Most Common Types of Employment Tax Non-compliance
Pyramiding. "Pyramiding" of employment taxes is a fraudulent
practice where a business withholds taxes from its employees but
intentionally fails to remit them to the IRS. The cause is often a lack
of profit or capital for operating costs, so the business owner uses the
trust funds to pay other liabilities. The quarterly employment tax
liabilities accumulate (or "pyramid") until the employer has little hope
of catching up. Businesses involved in pyramiding frequently shut down
or file for bankruptcy and then start a new business under a different
name starting the cycle over.
Unreliable Third Party Payers. There are two primary categories
of third party payers--Payroll Service Providers and Professional
Employer Organizations. Payroll Service Providers typically perform
services for employers such as filing employment tax returns and making
employment tax payments. Professional Employer Organizations offer
employee leasing meaning that they handle administrative, personnel, and
payroll accounting functions for employees who have been leased to
other companies that use their services. Many of these companies provide
outstanding services to employers. Unfortunately, in some instances,
companies of both types of services have failed to pay over to the IRS
the collected employment taxes. When these employment service companies
dissolve, millions in employment taxes can be left unpaid. Employers are
urged to exercise due diligence in selecting and monitoring a third
party payer. For example, when choosing a third party payer, employers
should look for one that is reputable and uses the Electronic Federal
Tax Payment System (EFTPS). This allows the business owner to verify
payments made on their behalf. Also, an employer should never allow
their address of record with the IRS be changed to that of the third
party payer.
Frivolous Arguments. Unscrupulous individuals and promoters have
used a variety of false or misleading arguments for not paying
employment taxes. These schemes are based on an incorrect interpretation
of "Section 861" and other parts of the tax law and have been refuted
in court. One variation of this scheme involves the improper use of Form
941c, Supporting Statement to Correct Information on Form 941, to
attempt to get a refund of previously paid employment taxes. Employer
participants could also be held responsible for back payments of
employment taxes, plus penalties and interest.
Offshore Employee Leasing. This scheme, which was designated as a
Listed Transaction by the IRS, misuses the otherwise legal business
practice of employee leasing. Under the typical promotion, an individual
taxpayer supposedly resigns from his or her current employer or
professional corporation and signs an employment contract with an
offshore employee leasing company. The offshore company indirectly
leases the individual's services back to the original employer using a
domestic leasing company as an intermediary. The individual performs the
same services before and after entering into the leasing arrangement.
While the total amount paid for the individual's services stays the same
or increases, most of the funds are sent offshore as "deferred"
compensation. The "deferred" compensation is then paid to the individual
as a "loan" or ends up in an account under the individual's control.
Promoters of these arrangements improperly claim that neither employment
taxes nor income taxes are owed on the "deferred" compensation. Because
it is a Listed Transaction those who use the scheme are required to
disclose their participation on current tax returns, and will be liable
for the unpaid tax and subject to penalties and interest. Civil and
criminal actions are being taken against promoters and participants in
offshore leasing schemes--one promoter was convicted of defrauding the
U.S. and sentenced to 70 months imprisonment, two other promoters have
been ordered by the courts to stop marketing the scheme and a San Diego
doctor plead guilty to tax evasion and is awaiting sentencing.
Misclassifying Worker Status. Sometimes employers incorrectly
treat employees as independent contractors to avoid paying employment
taxes. Generally if the payer has the right to control what work will be
done and how it will be done, the worker is an employee. Employers who
misclassify employees as independent contractors (and are not eligible
for relief under Section 530 of the Revenue Act of 1978) will be liable
for the employment taxes on wages paid to the misclassified worker and
subject to penalties.
Paying Employees in Cash. Paying employees wholly or partially in
cash is a common method of evading income and employment taxes. There
is nothing wrong with compensating an employee in cash, but employment
taxes are owed regardless of how the employees are paid. And the IRS
will build its case using all available information even if there are no
payroll records or checks.
Filing False Payroll Tax Returns or Failing to File Payroll Tax Returns.
Preparing false payroll tax returns intentionally understating the
amount of wages on which taxes are owed or failing to file employment
tax returns are methods commonly used to evade employment taxes.
S Corporation Officers Compensation Treated as Corporate Distributions.
In an effort to avoid employment taxes, some S Corporations are
improperly treating officer compensation as a corporate distribution
instead of wages or salary. By law, officers are employees of the
corporation for employment tax purposes and compensation they receive
for their services is subject to employment taxes.
The IRS encourages employees to report any concerns that an employer is
failing to properly withhold and pay federal income and employment
taxes. Employers must report employment taxes withheld from their
employees on Form 941. Employers are also responsible for filing Form
940, Employer's Annual Federal Unemployment Tax Return.
Second, you can be held personally liable for
the unpaid amounts. And, should you end up paying the amount personally,
you will not get a deduction for the payment. Moreover, any outstanding
liabilities are not discharged in bankruptcy.
Except in cases
where an employer is basically ignoring his or her responsibilities or
just using the withheld amounts for personal spending, holding onto the
withholdings generally indicates a serious cash flow problem that and
the business probably need outside assistance.
If you're already
behind one or more quarters, contact us immediatly. You
may have options. But the longer you wait, the worse it will get.
K.R. Hoffman & Co., LLC, counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how we can help you overcome your tax and business challenges. To start the conversation or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.