We Help With Payroll Tax Disputes
Business owners often find themselves ensnared in payroll tax controversies.
These controversies often arise from the late payment of payroll taxes or classifying employees as independent contractors rather than employees. There are several settlement initiatives that can be helpful in these cases.
In other cases, payroll tax controversies arise where the employer fails to withhold or remit the payroll taxes to the government. This often comes up when a business is struggling financially. By withholding but not remitting payroll taxes to the IRS, the business has in effect taken out a loan from the government without the government’s consent.
Regardless of the cause, failing to timely pay over payroll taxes can result in penalties and interest in excess of the initial tax that wasn’t paid.
A. The IRS Has Broad Powers When it Comes to Payroll Taxes
Our tax laws give the IRS broad powers pursuing businesses that have unpaid payroll tax liabilities. The IRS uses these powers and is particularly aggressive in pursuing businesses for unpaid payroll taxes.
This can put business owners in the position of having to shut down or sale their business, resulting in loss of employment and benefits for employers and employees and their families and loss of a hard-won business reputation. Employment tax problems can also trigger criminal liability. If that is not bad enough, the government may be able to pursue the business owner personally for the business’s unpaid payroll tax liabilities.
And even worse, interest on unpaid employment taxes cannot be abated. This is true even if the interest grows due to the IRS’s error or delay in processing the case.
The IRS recognizes its broad powers when it comes to employment taxes. The IRS employment tax levy is one example. This levy allows the IRS to take the taxpayer’s property without the procedural safeguards for other taxes.
Taking its cue from the laws granting these broad powers, the IRS has even asked a court for an injunction to force a taxpayer to comply with the employment tax laws–an unprecedented move–which the court rejected.
B. Employee vs. Independent Contractor Disputes
Many payroll tax problems stem from the mis-classification of employees as independent contractors. There are advantages for businesses to classify workers as contractors.
1. Advantages to Contractors
There are significant economic advantages for classifying employees as independent contractors. For example, employers do not have to pay Social Security, Medicare, and state and federal unemployment taxes for independent contractors. Besides the tax incentives, employers may favor independent contractors because of the reduced overhead, qualified employee benefit plan participation rules, or liability associated with independent contractors.
2. Tests for Determining Employment Status
Unfortunately there is no bright line rule for determining whether a new hire is an employee or an independent contractor. Instead there are at least three different sources of law that employers must consider. Specifically, employers must consider: Revenue Ruling 87-41, our common law which is created by various courts, and Section 530 of the Revenue Act of 1978. Unfortunately it is often not a simple matter to apply these sources of law to any one employer/employee relationship.
Courts will often consider a multi-factor analysis to make this decision. This includes considering:
- The degree of control exercised by the principal over the worker,
- The worker’s investment in his workplace,
- His opportunity to make a profit or suffer a loss,
- Whether the principal can fire him,
- Whether the work is part of the principal’s regular business,
- The permanency of his relationship with the principal,
- The relationship the parties believed they were creating, and
- The principal’s provision of employee benefits.
One only has to review the numerous court cases for these disputes to see how the court applies these factors.
Written contractor agreements may not be enough. Employers often try to avoid payroll tax problems by executing written non-employment agreement contracts. For the most part these agreements have proven to be inconsequential if they do not mirror the true nature of the business relationship. Therefore such agreements should be used as a tool for structuring the business relationship, for highlighting the factors that support independent contractor status, and for downplaying the factors that support employee status.
There are other business structures that can actually help. For example, running expenses through a S corporation can reduce the payroll taxes for the owner. But one has to take care with this if multiple legal entities are involved.
If that is not complex enough, there are several situations where employment taxes are not due. For example, the crewman’s exemption allows some boat owners to avoid employment taxes.
3. Dealing with Employee Classification Audits
To help reduce this uncertainty employers are able to request a determination from the IRS as to whether a new hire qualifies to be treated as an independent contractor.
Absent such a request employers face the prospect of a disgruntled independent contractor either taking the position that they were an employee on their tax returns or the contractor asking the IRS to rule that they were an employee. In this case, business owners are put in the position of having to go back and prove that the employee was actually an independent contractor. This can be difficult to do without the cooperation of the independent contractor. Luckily, the courts have held that the employer is able to access the employee’s IRS records for this purpose.
This often results in the employer being held responsible for significant payroll tax liabilities. In some cases the employer may qualify for the IRS Collection Settlement Program, which permits employers to admit that the independent contractor was an employee and the employer is only liable for one year worth of payroll taxes.
4. Statutory Employee Rules
In other cases, the contractor vs. employee dispute involves the statutory employee rules. These rules allow the employee to deduct business-related expenses. These rules apply to employees who are closer to being contractors than employees, such as traveling salesmen.
5. Whose Assets are at Risk?
Once the tax is assessed, the IRS has its normal tools to collect the taxes (it also has the employment tax levy, as noted above). This includes levying on or seizing the business’ property.
There are questions as to whose property the IRS can levy or seize to pay employment taxes. For example, what if the taxpayer operates as a single member LLC or disregarded entity? Does the IRS’s power reach the entity’s property or the owners?
In the past, the IRS disregarded the entity and looked to the owners assets. The rules changed for for employment tax periods beginning on or after January 1, 2009. The IRS is now limited to the business assets.
C. Trust Fund Recovery Penalty Disputes
Once employment taxes are assessed, the IRS may assess a trust fund recovery penalty (“TFRP”) against the business owners and operators. This penalty is set out in Section 6672.
Section 6672 provides that any person required to collect, account for, and pay over taxes who willfully fails to perform any of these activities can be assessed a TFRP.
The TFRP relates to amounts withheld from employee paychecks. Employers are generally required to withhold Federal income taxes and the employee’s share of FICA taxes from an employee’s wages. These funds are often referred to as “trust fund” taxes. The reference is to the fact that the employer holds the funds in trust from the employee pending payment to the IRS.
Employers are required to remit trust fund taxes to the government and they are fully liable if the taxes are not timely remitted. Moreover, the employer and the “responsible persons” are jointly and severally liable for a 100% TFRP if the taxes are not timely remitted.
This TFRP makes the business payroll tax liability a personal tax liability for the responsible person who acted willfully.
1. What is Willful Conduct?
Whether conduct rises to the “willful” standard requires a factual analysis. This analysis asks:
- Whether the responsible person had knowledge of a pattern of noncompliance as delinquencies accrued;
- Whether the responsible person received prior IRS notices that returns were not filed, or were inaccurate, or that employment taxes had not been paid;
- Actions taken by the responsible person to ensure its Federal employment tax obligations have been met after becoming aware of the tax delinquencies; and
- Whether fraud or deception was used to conceal the nonpayment of tax from the responsible person.
Absent willful conduct, there can be no TFRP.
2. Who is a Responsible Person?
A “responsible person” is anyone who: a) has the duty to perform or b) the power to direct c) the act of collecting, accounting for, or paying over trust fund taxes. What does this actually mean?
Generally “responsible persons” include anyone who has the ability to make financial decisions for the business, including owners, managers, and even lesser employees, such as bookkeepers.
This often includes the CEO and CFO for the business. The IRS will often try to impose the penalty on as many people as it can. It is common for the IRS to assess the penalty against anyone who signed checks for the business. The IRS has even tried to impose the penalty on the stay-at-home spouse of a business owner.
The law generally allows the penalty to be assessed against anyone who could have caused the business to pay the taxes. The analysis considers whether the alleged responsible person allowed other business expenses to be paid before the taxes are paid. This includes paying anyone, even if the payment makes it more likely that the business will survive and be able to pay more taxes to the IRS. Even if the responsible person uses their own funds by making a loan to the business to pay non-payroll taxes, the loan proceeds have to be used by the business to pay the payroll taxes.
Worse yet, there may not be a reasonable cause defense to the TFRP. The courts have differed in applying this defense.
The IRS revenue officer will conduct interviews to determine who can be a responsible person. The revenue officer will complete the Form 4180 in an in-person interview with each potential responsible person.
Taxpayers have to be very careful about this form, as the form can be admissible evidence that the taxpayer is “responsible” and non-payment was “willful.”
If there is any indication that the matter could result in criminal liability (which is discussed below), it may be necessary for the taxpayer to require the IRS to issue a summons before agreeing to a trust fund penalty interview. And even then, the taxpayer may assert his or her right not to respond under the Fifth Amendment. This is rare, but critical in cases that could result in criminal liability.
3. The IRS Often Fails to Send the Required Notice
But just because the IRS says a TFRP is due, does not mean that one is due. The IRS often fails to properly assess or record the TFRP on its books.
For example, it often fails to provide the taxpayer with the required notice before assessing the TFRP. There have been several court cases where the penalty was reversed for this very reason. The IRS has even refused to correct these errors when the taxpayers have notified the IRS of the errors. But that does not mean that you can simply avoid getting your mail with the hope that the notice isn’t received.
4. Dealing with TFRPs
There are a number of strategies for dealing with TFRPs. One is to simply wait for other responsible parties to pay the tax. This can work if the penalty is assessed against multiple parties and one of the parties is likely to pay or have assets that the IRS can easily seize or levy.
If you are going to pay the penalty, you may find that it makes sense to pay the oldest trust fund tax first. That can curtail the running of non-payment penalties and interest on the TFRP. If done correctly, you may also find that you can deduct the back taxes on your current year tax return.
But there are some things you cannot do. For example, you cannot challenge the amount of the penalty in some cases. Note that challenging the amount of the penalty may be different than challenging whether you are a responsible person. In some circumstances, challenging the amount of the penalty may preclude tax court review.
And recall as noted above, making a restricted loan to the business using personal funds does not work. This can result in liability for the business owner.
Criminal Liability for Employment Taxes
The IRS has other tools for collecting employment taxes. This includes pursuing criminal liability.
Section 7215 says that:
Any person who fails to comply with any provision of section 7512(b) shall, in addition to any other penalties provided by law, be guilty of a misdemeanor, and, upon conviction thereof, shall be fined not more than $5,000, or imprisoned not more than one year, or both, together with the costs of prosecution
Section 7512(b) provides that if the IRS serves a delinquent taxpayer with a written notice “delivered in hand,” the taxpayer must deposit all payroll taxes that are due within two banking days after payroll is made into a special trust account. This notice is provided on an IRS Letter 903.
This letter includes the following warning:
The DOJ can also pursue criminal charges based on the willful failure to report and pay over withheld taxes (Section 7202 of the Internal Revenue Code). Willfulness is evident if an employer paid net wages and didn’t leave enough funds to make the required tax payments or used withheld trust fund taxes for other purposes. Convictions may result in imprisonment and other penalties. Other criminal statutes may also apply.
If the taxpayer ignores and fails to abide by the warning in the Letter 903, then the taxpayer can be subject to prosecution under Section 7215.
If indicted and charged, the government still has the burden to prove all elements of the crime beyond a reasonable doubt. This is a high burden for the government to meet.
Get Help With Your Payroll Tax Problem
An experienced tax attorney can help you understand your tax obligations for your employees and help resolve your payroll tax problems. An experienced tax attorney can also help you review and structure your employee and independent contractor relationships so that your business does not run into these types of payroll tax problems.
Please call us at contact us online to schedule an appointment.or