Employment Tax Audits and Investigations (Federal and State)
Employers are required to withhold employment taxes from their employees. The government has been aggressively pursuing employment tax related examinations and related criminal investigations. In addition, they have been highly focused on worker classification issues (whether workers should properly be classified as independent contractors or employees), the “Trust Fund Recovery Penalty” (TFRP), non-filers, and officer compensation.
WORKER CLASSIFICATIONS – No definitive test exists to distinguish whether a worker is an employee or an independent contractor. The determination of whether a worker is an employee or an independent contractor is generally made under a facts and circumstances analysis that seeks to determine whether the worker is subject to the control of the service recipient, not only as to the nature of the work performed, but the circumstances under which it is performed.
Significant tax consequences might result if a worker was misclassified and is subsequently reclassified, e.g., as a result of an audit. For the employer, such consequences may include liability for withholding taxes for a number of years, interest and penalties, and potential disqualification of employee benefit plans. For the worker, such consequences may include liability for self-employment taxes and denial of certain business-related deductions.
The IRS Voluntary Classification Settlement Program (VCSP) is a voluntary program that provides an opportunity for taxpayers to reclassify their workers as employees for employment tax purposes for future tax periods with partial relief from federal employment taxes. To participate in this voluntary program, the taxpayer must meet certain eligibility requirements and apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.
TRUST FUND RECOVERY PENALTY – To encourage prompt payment of withheld income and employment taxes, including social security taxes, railroad retirement taxes, or collected excise taxes, Code §6672 authorizes the imposition of the Trust Fund Recovery Penalty (“TFRP”) against the individual responsible persons within a corporate entity who fail to take appropriate steps to assure payment of certain employment tax related amounts to the government. The amount of the penalty is equal to the unpaid balance of the trust fund tax and is based on the unpaid income taxes withheld, plus the employee’s portion of the withheld FICA taxes.
Personal liability for a corporation’s unpaid trust fund taxes can extend to any person who: (1) is a “responsible person,” i.e., one required to “collect, truthfully account for and pay over the tax,” and (2) has “willfully fails” to see that the taxes are paid. Willful use of employer funds for purposes other than the satisfaction of the trust-fund tax claims can, in certain situations, make a person individually liable for the petitioner personally liable to pay the taxes.
Persons who are neither corporate officers nor employees may be responsible for collecting and paying over trust fund taxes. Courts often look at the scope of the authority to act, not the title. A responsible person might include a director or corporate officer and have nothing to do with payroll, preparation and signing of checks, or the decision about what creditors to pay. Willfulness generally requires a “voluntary, conscious and intentional act” to prefer other creditors over the government.
If you or your company may be facing a potential criminal tax problem, we can help.