Payroll taxes collected by employers from employee paychecks and remitted to the government make up more than 70% of all taxes collected. Accordingly, payroll tax collections are critical to the ability of the government to function. It is no surprise, therefore, that the IRS and Department of Justice has made payroll tax enforcement a priority. Yet payroll taxes are probably the number one reason why small businesses get into tax trouble.
At the same time, the employee portion of payroll taxes—i.e. the workers wages—can easily be taken by the employer to fund the business during hard times. Stated differently, money withheld from employees are easily taken, but hard for the employer to pay back. Easy to take because there is no banker to say “no” and no paperwork to complete: Just keep the money and spend it.
The payroll tax debt, however, is the hardest to pay back because of the variety of penalties and interest that accumulate on these amounts due. And often, the payroll periods where the business is behind roll into one another, so that by the time the IRS catches onto the issue and shows up the liability has accumulated to such an extent that the business will never be able to repay the debt in full.
Up until now, the IRS and DOJ have pursued the unpaid payroll liabilities through civil enforcement against the company and by assessing the responsible individuals for the unpaid portion of the taxes that was withheld from the employee’s pay, referred to as the trust fund recovery penalty under Section 6672. The employer would be assigned to a revenue officer in the IRS Collection Division who would complete a trust fund investigation to determine how much was indeed owed and who was responsible for the failure of the employer to pay the payroll taxes. That revenue officer would propose the trust fund assessments against the responsible owner and/or key employees.
In addition to the personal assessment of the trust fund recovery penalty, the IRS could also seek an injunction against the employer so that the requirement to deposit and file on time was court ordered. This makes any violation going forward a violation of the court order, making it easier to shut the offending employer down.
Notice of federal tax lien would be filed and, in cases where it appeared the failure to account and pay over the payroll taxes was intentional, the IRS could pursue the case criminally. Criminal violations are referred to the DOJ for prosecution under either Section 7201, Section 7202, or both. The DOJ could also see court orders against recalcitrant owners to make sure they reported and deposited properly or would be shutdown.
The IRS has now upped the ante for employers who are behind.
Starting in June, the IRS has made it clear that its revenue officers will now be tracing where the unpaid payroll tax money actually went during their “trust fund investigation.” If it is determined that money went either to the owner or was spent for the owner’s benefit, the owner will now be facing a double whammy of the unpaid income taxes on those funds. In other words, if a business owner is pocketing payroll tax remittances to maintain a luxury lifestyle, it will more likely lead to prosecution.
For employers where the payroll tax money was not paid to the government, but was instead either paid to or used for the owner’s benefit, revenue officers are instructed to pull the owner’s 1040 income tax returns to see if the money that benefited them was reported as income. If the money was not picked up as income on the personal tax return, the revenue officer will either submit the returns and investigation records to the civil audit division for assessment of the tax and 75% civil fraud penalty or, if significant enough, simply refer the case to the IRS Criminal Investigation Division to review for criminal prosecution.
What this means for business owners and their tax professionals is that seemingly routine payroll tax debt might turn a civil obligation into a criminal tax nightmare in waiting. Tax professionals need to advise their client that a review of where the payroll tax money went is critical and, if either used for or paid to the owner, the preemptive amending of income tax returns must be done before the IRS shows up.
Understandably, the client business-owner will not like this. But the potential fallout from not doing this may be much worse.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Eric Green is one of the managing partners of Green & Sklarz LLC, where he focuses his practice on civil and criminal taxpayer representation. He is also the founder of Tax Rep Network, where he coaches accountants and attorneys on building their IRS Representation practices.
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