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Beware of “Borrowing” Time and Money from Uncle Sam’s Payroll Coffers

In this economy, many small businesses continue to struggle just to stay afloat and, out of desperation, find means of shuffling business funds around to pay immediately due bills and put off paying others. Some business owners have used employment tax withholding to use the government as a bank to ‘borrow the money for a short while’ during financially difficult times with good intentions to pay it back later. Others have been prosecuted for collecting employment taxes from their employees and willfully failing to pay them to the IRS. Former IRS Commissioner Mark W. Everson has stated that the “failure to pay employment taxes is stealing from the employees of the business.”

The IRS vigorously audits and investigates businesses for employment tax related issues. During the 2011 Fiscal Year, the IRS recommended 110 criminal employment tax investigations for prosecution. Of those, 85 were criminally charged by indictment or information, and 79 of the 85 were sentenced, resulting in an 81% incarceration rate, with an average 24-month sentence per case. These statistics are consistent with prior years’ investigations.

In just the last two months of 2011, business owners in Maryland, Virginia and Washington, D.C. alone have been convicted and sentenced for employment tax fraud.

On December 7, 2011, the owner of an Annapolis-based dental company was sentenced to 24 months in prison and ordered to pay $65,913 in restitution as well as back taxes owed to the IRS. For a five-year period, the dental company owner collected and withheld employment taxes from employees, but failed to pay over those taxes to the IRS. During those years, the owner paid $25,000 in employment taxes, but owed nearly $2 million more.

On November 18, 2011, in a similar case, a Virginia CEO was sentenced to 18 months’ imprisonment for failing to pay over employment taxes withheld from his employees’ paychecks between 2003 and 2008, culminating in a federal tax loss of $1.7 million. The CEO was also ordered to pay $956,006 in restitution.

On November 9, 2011, the sentences of co-owners of a Washington, D.C. based internet communications company ordered the husband-owner to serve 30 months in prison and the wife-owner to serve 10 months in prison for willful failure to pay more than $2 million in employment taxes to the IRS. The owners were also ordered to pay $2,420,927 in restitution to the IRS.

In criminal employment tax cases, the IRS must prove the employer acted willfully. But failing to pay over employment taxes without willfulness can also result in severe civil tax consequences.

Some businesses choose to turn over the administration of employee payroll to third-party companies, such as payroll service provides and professional employer organizations. Typically, these companies perform services for employers such as filing employment tax returns and making employment tax payments. Many of these companies provide outstanding services to employers. Unfortunately, in some instances, companies of both types of services have failed to pay over to the IRS the collected employment taxes. When these employment service companies dissolve, millions in employment taxes can be left unpaid. Employers should exercise due diligence in selecting and monitoring a third party payer. The IRS recommends, for example, that employers look for a third-party payer that is reputable and uses the Electronic Federal Tax Payment System (EFTPS). This allows the business owner to verify payments made on their behalf. Also, an employer should never allow their address of record with the IRS be changed to that of the third-party payer/service provider.

The IRS has further warned some S Corporations that treating officer compensation as a corporate distribution instead of wages or salary is improper. By law, officers are employees of the corporation for employment tax purposes and compensation they receive for their services is subject to employment tax.

As a business owner, if you find yourself trying to keep your business afloat by withholding employment taxes and filing employment tax returns (such as Forms 940 and 941), but haven’t paid over those withheld taxes, now is the time to consider becoming compliant with the IRS to avoid incurring more liability and, possibly, criminal charges.

For more information on employment tax issues or other tax assistance, contact us for a free consultation with an experienced Tax Attorney.

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