IRS Aggressively Pursues Payroll Tax Evasion With Civil And Criminal Enforcement Activity
The federal government’s tax enforcers, the Internal Revenue Service and the Department of Justice Tax Division, began 2016 with a continued focus on payroll tax cases. Generally speaking, payroll taxes include the federal income taxes that employers must withhold from their employees’ wages and Social Security and Medicare (“Federal Income Contributions Act” or “FICA”) taxes—a portion of which is withheld from employees’ wages and a portion of which is a matching amount paid by the employer. Finally, the term payroll taxes may also include the federal unemployment tax that employers must report and pay separately from the above-listed taxes—employees do not pay this tax nor it is withheld from their pay.
Businesses of all sizes may run into payroll tax problems by intentionally or unintentionally misclassifying employees as independent contractors or by favoring other creditors over making the required quarterly tax deposits when cash flow problems arise. In other instances, a dishonest employee might embezzle the withheld taxes unbeknownst to senior management, until it is too late. Due to the quarterly nature of these taxes, what might begin as an innocent mistake or “getting a little behind” can quickly balloon into an astronomical tax liability. The so-called Trust Fund Recovery Penalty (“TFRP”) of the tax code, allows the government to assess (and collect) that tax liability, with penalties and interest, personally against any individual who qualifies as a “responsible person” for ensuring the business’ payroll taxes are paid and willfully failed to do so.
This scenario often unfolds months or years after a failed business venture where an unsuspecting owner or shareholder of the business receives a letter in the mail from the IRS stating that they are personally liable for thousands, or in some cases millions, of dollars’ worth of unpaid employment taxes. It is important to note that the TFRP only refers to the “trust fund taxes,” or the taxes withheld from the employees’ wages. The remaining portion of the payroll taxes, i.e., the employer’s matching share of FICA taxes and the unemployment taxes, are not subject to the TFRP. That said, the IRS is free to pursue the business entity itself for those unpaid taxes in addition to any one or more responsible persons individually for the unpaid trust fund taxes. To defeat the IRS’ assertion of the TFRP, an individual has the burden of proving either that he or she was not a responsible person; that he or she did not willfully fail to collect and pay over the taxes; or in some cases he or she can demonstrate the lack of present or future collection potential.
Recent civil enforcement activity
The government kicked off the New Year by highlighting two permanent injunctions issued against businesses with employment tax problems. On January 4, 2016, a federal judge in Maryland issued an order permanently enjoining a Baltimore-area stone importing business and its owners from accruing payroll tax liabilities. Among other requirements in the injunction, the business and its owners are prohibited from assigning any property or making any payments until the outstanding payroll taxes are paid to the IRS.
On January 19, 2016, a federal judge in South Carolina issued an order permanently enjoining a trucking company and its owner from violating their payroll tax obligations. According to the complaint filed in that case, the various companies controlled by owner Tony McMillan owed more than $2.7 million in employment and unemployment taxes. The complaint also accused the defendants of “pyramiding” payroll taxes for the period from 2009 from 2014. The IRS uses the term pyramiding to describe a situation where a business withholds taxes from employees but does not pay them to the IRS and then closes down the business and files for bankruptcy protection. The cycle continues when the business reopens under a new name and continues the practice of withholding, not paying over to the IRS, and closing down the business. While businesses routinely file for bankruptcy protection for any number of legitimate reasons, if the IRS views a business as pyramiding its payroll taxes, the Service will certainly view this as willful behavior for the purposes of the TFRP and will often refer such a case for criminal prosecution.
Criminal enforcement of payroll tax evasion
In addition to substantial taxes and penalties, Section 7202 of the tax code makes it a felony offense punishable by up to five years in prison for any person required to collect, account for, and pay over any tax to willfully fail to collect or truthfully account for and pay over such tax. Again, because businesses, with some exceptions, are required to file IRS Forms 941 each quarter with their quarterly tax deposits, a responsible person who willfully fails to do so could face four separate counts of violating Section 7202 per year of non-compliance.
While the Department of Justice Tax Division typically reserves criminal prosecution for the more egregious cases, such as a repeated pattern of withholding trust fund taxes and not paying them over to the IRS or business owners who divert the trust fund taxes to their own personal benefit by purchasing luxury items or the like, the elements of the criminal offense are practically identical to the TFRP. The main distinction is that in a criminal case the government bears the burden of proving the defendant guilty beyond a reasonable doubt. There is also a legal difference between the willfulness standard in criminal cases compared to the willfulness standard in civil TFRP cases, however, the IRS often views conduct through the same willfulness lens. Cases involving suspected pyramiding, perceived abuse of employee leasing companies, or paying employees in cash will routinely draw a referral for criminal prosecution on top of aggressive civil enforcement tactics.
In a case that will continue to play out in 2016, an Oregon attorney was indicted by a federal grand jury in Portland on ten counts of failing to pay over approximately $184,791 in payroll taxes. According to the indictment, the attorney caused over $300,000 to be paid to his personal bank accounts during the same period of time that employment taxes were withheld from his law firm employees’ paychecks but not remitted to the IRS. While this defendant is innocent until proven guilty beyond a reasonable doubt, he faces an uphill battle if the indictment is correct in alleging that he was the “sole member and general manager” of the law firm. Often, one defense in this type of criminal tax case is to point to another person at the company whose responsibility it was to pay the payroll taxes over to the IRS, thus arguing a lack of willfulness on the part of the defendant.
In the modern business environment, business owners face innumerable demands on their time and resources. However, anyone in a position to be considered responsible for making payroll tax payments cannot afford to let those issues go unaddressed. The best time to seek counsel experienced with these matters is before the IRS can assess the TFRP against any individuals or at least before the onset of a criminal investigation.
For more information, please contact Matt Mueller at email@example.com or 813.347.5142. Mr. Mueller is a former federal prosecutor with the Department of Justice’s Tax Division and the U.S. Attorney’s Office in Tampa. His practice areas include white collar criminal defense, criminal tax defense, state and federal regulatory enforcement actions, internal investigations, and civil litigation.