Conviction as a Deterrent for Employment Tax Crimes?

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Subchapter S Corporation Losses Limited By Tax Basis
Subchapter S Corporation Losses Limited By Tax Basis
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Failing to pay taxes to the government is a crime, including failing to pay employment taxes withheld by employers from employee wages.

Employment tax fraud includes cases involving paying employees in cash so there is no record of payments, filing false payroll tax returns, failing to file payroll tax returns, and pyramiding.

Pyramiding is particularly problematic for the IRS. It occurs when individuals operate a business that withholds taxes from its employees but intentionally fails to pay over those tax payments to the IRS, quarter after quarter. These individuals might then start a new business and begin again the pattern of withholding taxes but not remitting those taxes to the IRS.

A recent report by the Treasury Inspector General for Tax Administration (“TIGTA”) suggests that the government has not adequately enforced employment tax crimes. The report notes that the IRS’s lax enforcement has resulted in widespread non-compliance.

What TIGTA Found

TIGTA’s report, titled “Case Selection Processes Result in Billions of Dollars in Potential Employer Underreported Tax Not Being Addressed,” highlights several concerning statistics regarding employment tax noncompliance:

  • As of December 2015, 1.4 million employers owed approximately $45.6 billion in unpaid employment taxes, interest, and penalties.
  • In FY 2015, the IRS assessed the Trust Fund Recovery Penalty (TFRP) against approximately 27,000 responsible persons, which is 38 percent fewer than five years prior due to diminished revenue officer resources.
  • The number of employers with egregious employment tax noncompliance (20 or more quarters of delinquent employment taxes) has more than tripled over a 17-year period.
  • Despite the willful failure to remit employment taxes being a felony, there are fewer than 100 criminal convictions per year.

These statistics do paint a picture where lax enforcement may result in non-compliance.

Lack of Deterrence

TIGTA notes that the minimal number of criminal convictions likely has little deterrent effect. Non-compliance with employment tax laws is at an all-time high, enforcement efforts have waned, and criminal convictions for employment tax crimes are almost non-existent. TIGTA advocates for increased criminal enforcement as a means to deter non-compliance and encourage voluntary compliance from other similarly-situated taxpayers.

Deterrence involves discouraging an action through instilling doubt or fear of the consequences. In the context of employment taxes, this assumes that businesses are aware of the IRS’s lax enforcement and, knowing this, willfully fail to remit employment taxes withheld from employees’ wages.

IRS’s Position on Enforcement

The IRS largely disagreed with TIGTA’s findings and recommendations. According to the report, the IRS indicated that cases should only be considered for criminal referral where there is a firm indication of fraud. The IRS’s stance is based on the belief that most non-compliance is due to circumstances beyond the taxpayer’s control, such as mismanagement by accounting personnel or financial difficulties.

Analysis of Non-Compliance Factors

Circumstances Beyond Control

From our limited perspective, few taxpayers are aware of how the IRS handles unpaid employment taxes until they are contacted by the IRS. Even then, they may not realize that enforcement is lax. Often, employment taxes are not paid over to the government due to circumstances beyond the taxpayer’s control. For example, accounting personnel might take steps to hide the issue, leading to non-compliance without the employer’s direct involvement. In such cases, increased criminal enforcement would likely do little to change the outcome.

Financial Hardships

In many cases, employment taxes are not paid because of financial hardships. Employers may face the difficult decision of paying suppliers or paying wages to employees so that they can keep their jobs, versus paying the employment taxes to the government. From a criminal prosecution perspective, the TIGTA report is correct in noting that the law states willful failure to pay the tax is a crime and that an evil motive or bad purpose is not necessary for a conviction. However, prosecuting employers under these circumstances may not be the best use of limited government resources.

TIGTA’s Focus on Criminal Deterrence

The TIGTA report provides a detailed analysis of the IRS’s case selection process and the challenges in enforcing employment tax compliance. The IRS’s focus has been on civil enforcement rather than criminal prosecution, with criminal referrals being reserved for cases with clear indications of fraud. This approach is reflected in the relatively low number of criminal convictions despite the high number of non-compliant employers.

The Takeaway

The TIGTA report highlights a significant issue in the enforcement of employment tax compliance. While the IRS has valid reasons for prioritizing cases with clear fraud, the lack of criminal enforcement may undermine the deterrent effect necessary to encourage broader compliance. The report suggests that increasing criminal prosecutions for willful non-compliance could enhance deterrence, but it also raises questions about the fairness and efficacy of this approach, particularly for employers facing genuine financial difficulties.

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