Civil and Criminal Tax Enforcement of Employment Taxes

Civil and Criminal Tax Enforcement of Employment Taxes

Editors Note: Practitioners should be mindful of a renewed focus on employment tax enforcement. While not relying on new laws, the IRS and the Department of Justice have recently prioritized enforcement, and particularly criminal enforcement, of existing employment tax laws. The following will help show how these concerns can play out for you and your clients.

You’re sitting in your office with a fairly new client who is the vice president for finance of a medium-size corporation. He tells you that he signed the company’s employment tax returns, but didn’t really know what was in them. He claims that the controller was responsible for the numbers, as well as handling actual payment of the taxes to the IRS.

Unfortunately, the controller failed to remit $50,000 in payroll taxes, but she now assures the vice president that the company can “make it up” next quarter, when a new contract is going to come on line. Your guy’s antsy, because he’s heard that the IRS really doesn’t like this practice, and wonders about his personal downside. What do you tell him?

Well, first, some preliminaries. You have to understand who your client is. Is he the individual sitting in front of you, the company, or both? If the latter, have you explored carefully whether there is a conflict of interest, or potential conflict? If you represent the company, and particularly if there are other officers who are potentially liable, you may need to suggest strongly that he find his own attorney.

Second, tell him that no matter what he’s heard about a shrinking IRS workforce and hostility from a Republican Congress, enforcement still has real teeth. The company holds payroll taxes in trust for the U.S. Government, which imposes heavy fiduciary liability. Moreover, the individuals from whom tax has been withheld are entitled to claim it as a credit on their own individual returns, whether or not the company has remitted them. Unless the IRS collects them, either from the company or the individual “responsible” for them, it gets whipsawed: it’s out the employment taxes and it’s out the credit that the employees rightly can claim.

Third, you can alert him that the IRS’ Criminal Investigation division recently announced the creation of a National Coordination Investigation Unit (NCIU) to ensure that every field office focuses on possible employment tax prosecutions. It is considered one of the NCIU’s “core missions” and one of its top priorities.

Fourth, you can tell him that while there is some dispute within the government whether actual fraudulent intent is required to sustain a prosecution for failure to remit employment taxes, the Department of Justice (which litigates all criminal tax actions) takes the position that there is not. The “willful” failure to pay over taxes does not always require the intent to defraud the government, by purchasing vacation homes and motorboats while not remitting payroll taxes.

Fifth, tell him that “making it up next quarter” is the road to perdition, and that almost all failures to remit did not start out with the intent to steal from the government. It simply is easy—far too easy—to encounter difficulties next quarter, and then the quarter after that, until the problem becomes insurmountable.

You can add that the IRS can assess a portion of the payroll taxes (the withheld income taxes and half of the Social Security taxes) directly against the individuals who are “responsible” for this function.1 This is usually referred to as the “trust fund penalty,” although strictly speaking, it is not a penalty at all, but merely a means by which the IRS opens up a second source to tap for collection. This goes against them directly, personally, under their own Social Security number. That it dings their FICO score becomes the least of their problems. Tell him that signing the returns is a huge strike against him, even if he didn’t really understand the numbers, one that can be overcome only by herculean effort, and that going forward, he should be very careful about what he signs.

What if both the vice president and the controller are both considered “responsible persons”?  The IRS can assess the full $50,000 against both and, if it actually collects it from one, the other can sue for contribution in a separate federal court action, in addition to any contribution rights he has under state law. Unfortunately, this federal right of contribution is only 20 years old and certain aspects remain unclear.2 For example, must the vice president pay the full $50,000 before seeking contribution, or only one dollar more than his “proportionate share?”

Must the IRS have made its own determination that the controller was “responsible,” or is the vice president permitted to build his own case, in effect succeeding to the IRS’ trust fund penalty determination function that the controller is also in the soup? Fortunately, here, the vice president is at least entitled to demand information from the IRS on what trust fund penalty determinations it has made, if any, against other people, information that would otherwise be protected by disclosure law.

In short, there are a huge number of potential civil pitfalls here for the vice president. If he’s not the vice president at all, but the president of his own small company and enjoying a lavish lifestyle, criminal prosecution is a real possibility. But then again, you don’t have to be Al Capone or the star of “The Wolf of Wall Street” to garner serious attention. Merely owning a small food preparation business but stating, according to the Revenue Agent in your employment tax audit, that your workers preferred to be paid in cash and you didn’t think it necessary to file returns, can be enough.3

[1] In a kinder world, being considered a “responsible person” would be a compliment. In the tax world, it is not.

[2] Prior to 1996, the absence of such a right was clear, and was widely considered a serious injustice. Sometimes Congress does do the right thing.

[3] True story.