When a company assumes the role of payroll administrator, there are considerations to protect the assets of the company from risk related to various employment taxes.
“There are several circumstances that may cause a company to run the risk of becoming noncompliant or considered evasive of employment withholding tax obligations, requiring employers by law to withhold taxes from their employees, including federal income taxes and other taxes required by the Federal Insurance Contributions Act such as Social Security and Medicare taxes,” says Walter McGrail, senior manager, Cendrowski Corporate Advisors LLC.
Although not discussed here, these same requirements apply to other employer taxes such as FUTA and taxes required by any states.
Smart Business spoke with McGrail about employment tax risks and what companies can do to mitigate them.
What are employment tax risks, and are they a realistic issue?
Companies are required to withhold taxes and remit them to the Internal Revenue Service via an authorized financial institution, as established by the Federal Tax Deposit Requirements. When the taxes withheld are not remitted, or not remitted in a timely manner, the company may be liable for penalties, interest, or, in the case of proven evasion, prosecution. Noncompliance may result in penalties and interest, whereas evasion may subject the responsible parties to criminal and civil sanctions
According to the IRS, for fiscal years 2009 to 2011, it initiated approximately 500 investigations into employment tax evasion. Of these cases, more than 40 percent were investigated, recommended for prosecution, indicted and ultimately sentenced. Additionally, of those sentenced, 80 percent were incarcerated by means of either federal prison, halfway house, home detention, or some combination, lasting an average of nearly 24 months.
These penalties are most commonly levied against the responsible parties, including, but not limited to, corporate officers, shareholders, members and partners.
What are the most common methods, or schemes, related to employment tax evasion?
There are several common scenarios that could result in evasion or simply result in noncompliance when it comes to employment taxes. The most common, according to the IRS, involve pyramiding, utilizing unreliable intermediaries to remit the tax and misclassifying wages or salaries based on worker status or officers’ compensation treated as distributions. Due to the lengths someone may go to in order to evade employment taxes, there is even a listed transaction related to employment and the use of offshore employee leasing to evade these taxes.
If employment taxes are automatically withheld, how can companies be put at risk?
Companies are at risk when withheld taxes have not been paid in a timely manner, as prescribed by the IRS. Fraud can be an integral part of employment tax evasion.
Pyramiding is one of the more common practices. This involves the employer not remitting the taxes and using the monies to cover other liabilities or operating shortfalls. If the employer continuously uses this practice to continue the operation of the company, the amount can accrue over time (pyramid) to the point where business operations cannot recoup the funds utilized and the company is left with a tax liability and no cash. The frequent result is the business going under.
Unreliable payers can also be an issue. A payer can be either a third party or related (someone employed by the company). Both types of payers can be instrumental in causing the company to be at risk of noncompliance.
Third-party payers generally fall into one of two categories: Payroll Service Providers (PSP) and Professional Employer Organizations (PEO). PSPs typically assume the role of payroll administrator and the responsibility for making employment tax payments and filing the appropriate employment tax returns. PEOs effectively lease employees and assume the role of human resources, managing the administrative, personnel and payroll functions for the company. Tax issues can arise when either type of third-party payer is in control of employment taxes or the company dissolves. This can leave employment taxes unpaid.
If the company utilizes an internal department or employee to pay employment taxes, there are different ways the company can be exposed to risk. One way could be rooted in fraud. If the payer were to pay taxes but not properly credit them to the company’s tax account, the company would still have an employment tax liability and no funds to pay the taxes owed.
Much like other frauds that involve payables, funds can be paid or transferred to a taxing authority while being applied to a different account. The company believes its tax liabilities are being properly paid and may not become aware of an issue for months or years.
How can companies safeguard against employment tax evasion and noncompliance?
There are no guarantees, but one way to reduce possible exposure is to exercise due diligence when engaging a third-party or related payer.
Monitoring is essential to the process. The company can insist on paying all federal taxes electronically, utilizing the Electronic Federal Tax Payment System (EFTPS), which allows users to access tax payment history to ensure payments were made and applied to the appropriate tax account. Additionally, verifying and matching the amounts paid against the information reported on the Employer’s Quarterly Federal Tax Return (Form 941) can aid in reducing noncompliance and the possibility of employment tax evasion.
Additionally, ask your CPA to look at wages and related withholdings as part of the tax return preparation for your company.
Walter McGrail, CPA, is senior manager of Cendrowski Corporate Advisors LLC. Reach him at (866) 717-1607 or [email protected].
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