Payroll tax penalties are scary when they are assessed against a client. They are even scarier if they are assessed against a CPA who provides payroll services to the client. The Erwin case is an important reminder that an accountant can be held liable for a client's unpaid employment taxes. In it, the court concluded that accountants had significant authority over the finances of the client, so they were "responsible persons" under Sec. 6672 (Erwin, No. 1:06CV59 (M.D.N.C. 2/5/13)). Of course, the owner of the business was held to be a responsible person as well. Nevertheless, the two accountants were each found jointly and severally liable for $325,000 plus penalties and interest. That is a time-consuming and expensive lesson. This item reviews the relevant requirements, procedures, or other issues for CPAs who offer payroll services.
Follow an Engagement Letter
CPAs who perform payroll and sales tax return preparation—which might not be within the purview of the Statements on Standards for Accounting and Review Services (SSARS)—should use engagement letters for those services. Two-party, signed engagement letters can minimize confusion and clarify responsibilities between the client and the CPA, outline fee and payment terms, and emphasize the importance of filing deadlines, logistics, and other key aspects of the client arrangement, such as how the CPA can resign from the engagement. In Erwin, if the accountants had promptly resigned in writing, they may have avoided such hard scrutiny.
Procedures for CPAs That Process Clients' Payroll Checks and Make Tax Deposits
CPAs processing payroll checks and making tax deposits online should consider access and security issues and be careful if they have access to a financially troubled client's bank account. If the CPA is printing payroll checks, the checks should be kept in a locked, secure cabinet, and only personnel who process payroll should have access to them. For online tax deposits made via the Electronic Federal Tax Payment System (EFTPS) or various state websites, the user names and passwords for the client should also be kept secure, and this also applies to the passwords for software used to process the payroll and for direct deposit of paychecks.
If a CPA is performing accounts payable or bookkeeping functions for a client that is facing financial difficulties, as in Erwin, he or she should not follow the client's instructions to pay other creditors if he or she knows the payroll tax withholdings are not being paid. CPAs should advise clients to pay the government before paying vendors—especially before making draws or distributions to owners. The bottom line for CPAs who have access to client bank accounts is to guard secure client payroll information and to be cautious if the client asks them to delay tax deposits or if they know the client is having cash flow issues.
Arrangements the IRS Has Defined for Outsourcing Payroll Duties
The IRS has identified three types of third-party arrangements by which a company may outsource its payroll functions. It is important to know these, as slightly different duties and responsibilities are associated with each arrangement.
1. Payroll service provider (PSP): A PSP prepares the paychecks for the client; prepares Forms 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, and 941, Employer's Quarterly Federal Tax Return, using the client's employer identification number (EIN), and has them signed by the client; makes federal tax deposits; and/or prepares the Forms W-2, Wage and Tax Statement, for the client's employees, using the client's EIN. A PSP assumes no liability for its clients' employment tax withholding, reporting, payment, and/or filing duties.
2. Reporting agent (RA): An RA is authorized to perform certain acts on behalf of clients' employees. Form 8655, Reporting Agent Authorization, must be filed authorizing the RA as the client's agent. Then the RA can prepare and electronically file Forms 940 and 941, signing the returns as the RA. The RA also deposits and pays payroll tax liabilities on behalf of the client, using the client's EIN. Like a PSP, an RA assumes no liability for its clients' employment tax withholding, reporting, payment, and/or filing duties.
Rev. Proc. 2012-32 requires an RA to provide the client with a written statement when it enters into a contract for services with the client, reminding the client that it is the client's responsibility to file returns and pay taxes, and advising the client to enroll in EFTPS so that it can monitor its account and ensure that the RA is making timely payroll tax deposits. CPAs that electronically file Forms 940 and 941 as the RA for clients should be aware of the requirements of filing Form 8655, having a signed engagement letter with the client, and always providing the client with a copy of each return filed.
The Treasury Inspector General for Tax Administration (TIGTA) reported to the IRS in March that more processes are needed to link third-party payers, especially PSPs, to employers, to reduce risks related to employment tax fraud (see TIGTA Rep't No. 2015-40-023). So more regulations may be coming for third-party payroll providers. Currently, when a PSP or an RA enrolls a client in EFTPS, the client receives a letter with an inquiry PIN (personal identification number), so that it can monitor the payments made by the third-party provider.
3. Form 2678 agent (sometimes called a Sec. 3504 agent): In this arrangement, the agent files an aggregate return for all clients, using the agent's EIN. Form 2678, Employer/Payer Appointment of Agent, is signed and filed by the client and the agent, and in this case, both the client and the agent are liable for paying the employment taxes and filing returns. Rev. Proc. 2013-39 describes this type of arrangement, sets forth instructions for agents, and explains their obligations regarding employment taxes. While most CPAs do not work with this type of arrangement, they should be aware that it does exist.
Issues When Representing a Client Regarding a Payroll Tax Return the CPA Prepared
If a CPA is a PSP, the Forms 940 and 941 are filed on paper and are signed by the client. In those cases, the CPA must complete and sign the paid preparer's section of the form. The CPA must enter his or her preparer tax identification number (PTIN) in the space provided, enter a complete address, and enter the firm's name and EIN if the CPA works for a firm. A CPA that is an RA generally does not complete this section. In most cases, a CPA who is a PSP should also complete the section on each form that authorizes the CPA as a third-party designee with respect to that return. If that section is completed, a five-digit PIN should be entered, and the designee must refer to that PIN when discussing the return with the IRS.
This is not the same as a Form 2848, Power of Attorney and Declaration of Representative, and it only applies to a specific return. It simply authorizes the designee to provide information about the return, contact the IRS about the return, and respond to an IRS notice related to the return that the client has shared with the designee. This authorization expires one year from the due date of the form. Nevertheless, it is prudent for a CPA to complete this section so he or she can assist a client if problems arise relating to the return.
Understanding Who Is a "Responsible Person"
In Erwin, the accountants were held liable for the trust fund recovery penalty under Sec. 6672 as responsible persons. CPAs should understand that under Sec. 6672, a penalty equal to 100% of the total amount of the tax withheld from employees' checks but not paid can be assessed against any responsible person—someone who is required to collect and pay over tax who willfully fails to do so. Several factors may indicate whether someone is a responsible person, but CPAs should be aware that a CPA acting as a PSP or an RA can be considered a responsible person.
The penalty applies only to willful violations, so the responsible person must have been or should have been aware of the outstanding taxes and either intentionally disregarded the law or was indifferent to its requirements. According to the IRS, using available funds to pay other creditors when the business does not pay the employment taxes is an indication of willfulness (Internal Revenue Manual §18.104.22.168.3). Whether someone is a responsible person is based on the facts and circumstances of each case, but for CPAs providing payroll services, it is an issue that cannot be ignored.
Payroll services can be a profitable line of business for CPAs. By understanding their responsibilities and taking them seriously, CPAs can avoid penalties while providing a valuable service to clients and developing long-standing relationships.
Valrie Chambers is an associate professor of accounting at Stetson University in Celebration, Fla. Jan Lewis is a Tax Partner with Haddox Reid Eubank Betts PLLC in Jackson, Miss., and is also the chair of the AICPA Tax Practice & Procedures Committee. For more information about this column, contact Prof. Chambers at email@example.com.