It’s back! Tax time is here and with it comes the tax scam crowd, bent on taking your money and likely to get you into deep trouble with the IRS. Both the IRS and your friends here at ABC urge you to keep clear of these plans. After all, staying right with the taxman is one of the best things you can do for your business and yourself.
As an employer, you must report employment taxes withheld from your employees on Form 941, Employer’s Quarterly Federal Tax Return. You are also responsible for filing Form 940, Employer’s Annual Federal Unemployment Tax Return. Employment taxes must either be paid electronically or to an authorized bank or financial institution according to federal tax deposit requirements.
To that end, here are eight major tax scams identified by the IRS that you should watch out for. In some, you are the victim; in others you are the one breaking the law. In both cases, you are responsible for the taxes, interest and penalties, so be careful.
Pyramiding. This is a fraudulent practice where a business withholds taxes from its employees but intentionally fails to remit them to the IRS. Often, the reason for this is a need for operating capital. The quarterly employment taxes accumulate—as in a pyramid—until the employer simply cannot catch up, at which time the business involved usually shuts down or files for bankruptcy. Frequently, the owner of the failed business opens a new one using a different name and starts the cycle over again.
Unreliable Third Party Payers. There are two types of third party payers, payroll service providers and professional employer organizations. Payroll service providers typically perform services for employers such as filing employment tax returns and making employment tax payments. Professional Employer Organizations offer employee leasing, which means that they manage administrative, personnel, and payroll accounting functions for employees who have been leased to other companies. In some instances, companies of both types have failed to pay the collected employment taxes to the IRS. Employers need to exercise care in selecting a third party payer. Find one that is reputable and uses the Electronic Federal Tax Payment System (EFTPS). This permits the verification of payments made on behalf of the business. Finally, a business should never permit its address of record with the IRS to be changed to that of the third party payer.
Frivolous Arguments. There are many unscrupulous people—both taxpayers and scheme promoters--who have used a variety of false or misleading arguments for not paying employment taxes. The courts have uniformly rejected these arguments, all of which are based on an incorrect interpretation of “Section 861” and other parts of the tax law. Recent court cases have resulted in criminal convictions of promoters while employers participating in these plans have also been held responsible for back taxes, interest and penalties. See sidebar.
Offshore Employee Leasing. This scheme misuses the otherwise legal business practice of employee leasing. Typically, an individual taxpayer supposedly resigns from his or her current employer and signs an employment contract with an offshore employee leasing company. The offshore company indirectly leases the individual’s services back to the original employer using a domestic leasing company as an intermediary. The individual performs the same services before and after entering into the leasing arrangement. While the total amount paid for the individual’s services stays the same or increases, most of the funds are sent offshore as “deferred” compensation. This “deferred” compensation is then paid to the individual as a “loan” or ends up in an account under the individual’s control. Promoters improperly claim that neither employment taxes nor income taxes are owed on the “deferred” compensation. Those who use the scheme must disclose their participation on current tax returns, and will be liable for the unpaid tax and subject to penalties and interest. Civil and criminal actions are being taken against promoters and participants. These actions have so far resulted in imprisonment, and injunctions while others are awaiting sentencing.
Misclassifying worker status. Sometimes an employer will incorrectly treat employees as independent contractors to avoid paying employment taxes. The standard to determine whether someone is an independent contractor is whether or not the employer has the right to control what work will be done and how it will be done. If the employer has that right, then the person in question is an employee. If not, then they are an independent contractor. Employers who misclassify employees, as independent contractors will be liable for the employment taxes on wages paid to the misclassified worker and will be subject to penalties.
Paying Employees in Cash. This is a common way to evade income and employment taxes. It must be remembered that employment taxes are owed regardless of how the employees are paid and that the IRS will make its case by using any and all available information, even if there are no payroll records or canceled checks.
Filing False Payroll Tax Returns or Failing to File Payroll Tax Returns. Like cash, preparing false payroll tax returns, or failing to file employment tax returns at all, are common methods of employment tax evasion. Again, those who do this are subject to civil and criminal penalties.
S Corporation Officers Compensation Treated as Corporate Distributions. To avoid employment taxes, some S Corporations improperly treat compensation for their officers as corporate distributions instead of wages or salary. This is illegal as the law sees officers as employees for tax purposes, which means that compensation for their services is subject to employment taxes.
Remember, the taxpayer is ultimately responsible for their own taxes. To that end, IRS policy encourages employees to report any concerns they may have that their employer is failing to properly withhold and pay federal income and employment taxes. Taxpayers can contact the IRS at 1-800-829-1040 or report suspected tax fraud by calling 1-800-829-0433. —Charles Cooper
