An employer is responsible for withholding federal income tax and the employee's share of Federal Insurance Contributions Act taxes (FICA, which consists of Social Security and Medicare taxes) from the wages it pays to that employee. The employer is also responsible for its share of FICA taxes and Federal Unemployment Tax Act (FUTA) taxes. All of these employment taxes must be paid to the federal government, usually at least quarterly.
Who is a responsible person?
Many employers who fail to pay over these amounts do not do it willfully, but are often caught by cash flow problems that they believe will turn around. Nonetheless, the government can and will impose a 100% trust fund recovery penalty under Sec. 6672 on "responsible persons" who were required to pay over the money or who controlled the funds that should have been deposited. Many people associated with a business may be found to be a responsible person, including corporate officers, treasurers, managers, and even bookkeepers, in certain circumstances.
Trust fund recovery penalties
The worst thing when representing someone with employment tax issues is that the IRS will want to assert the trust fund recovery penalty against the client, thus making the client responsible personally for the taxes owed even when the business was conducted in corporate form. Any responsible person can be held personally liable for the trust fund recovery penalty, which can amount to 100% of the unpaid withheld tax.
The IRS will assess the penalty against any person who it believes was responsible for the nonpayment of the taxes, which could include a person who merely signed a Form 941, Employer's Quarterly Federal Tax Return. In two recent cases, the IRS tried to assess the penalty against people who didn't even have that level of involvement.
In a Tax Court case decided this year, the IRS tried to assess the trust fund penalty against a 77-year old man who spent a lot of time at a restaurant (and whose son managed it together with another person), but who had no other connection, just because he occasionally signed some checks for the restaurant (Shaffran, T.C. Memo. 2017-35).
In another recent case, Fitzpatrick, T.C. Memo. 2016-199, the IRS tried to assess trust fund penalties against the wife of an investor in a business who proved that she spent her time caring for her disabled son, and was not a responsible person. She had opened a bank account for the business to help out her husband, who was out of town at the time, and she was authorized to sign checks for the business.
Although the IRS was not successful in either case, the cost in time, money, and emotional distress to the people who were forced to litigate their lack of responsibility for the unpaid taxes was probably substantial.
In addition to the civil trust fund recovery penalty, when an employer willfully fails to pay over employment taxes, the Justice Department can pursue criminal prosecution under Sec. 7202. Right at the end of this tax season, the Justice Department issued a stern warning to employment tax evaders. The warning is a change in what we have previously heard from the government regarding employment taxes. The press release forthrightly discusses criminal offenses associated with the willful nonpayment of employment taxes.
Willful nonpayment of employment taxes is a felony under Sec. 7202, punishable by a fine of up to $10,000, imprisonment up to 5 years, or both. When an employer withholds money from its employees' paychecks and then does not pay it over to the Treasury, this act is considered embezzling money from the U.S. Treasury. Usually, the IRS only prosecutes high-profile cases. The Justice Department press release describes a number of these. Still, there is a risk, depending on the severity of the noncompliance, that a client could be pursued criminally for not paying employment taxes.
The simple fact that the Justice Department issued this warning about criminal prosecution should be a wake-up call to any practitioners who are dealing with clients experiencing employment or payroll tax issues. If a tax practitioner's client owes employment taxes, and the case turns criminal, it is important to get an attorney involved immediately.
How to help
One route to help clients who can't handle their employment tax responsibilities is to offer a payroll service for them. Practitioners who do this (or the commercial payroll services they use) debit the payroll and taxes out of the client's account and pay the taxes when they are due. For example, my company has a payroll service that directly debits the payroll and payroll taxes out of the client's account, directly deposits the net payroll checks into the employee's account, and pays the taxes when they are due. This service even includes taking care of the employer tax forms: Forms W-2 and 1099.
One thing is for sure, when agencies such as the Justice Department are getting involved in employment taxes, you can be sure that the IRS is focusing on it. The problem is that clients don't see how harsh the penalties for nonpayment of payroll taxes are until they go through the process.
Craig W. Smalley, MST, is an enrolled agent and the founder and CEO of CWSEAPA PLLC, which provides accounting and financial services.