Abo and Company Finally Agrees with the IRS

(at least on tips for employers who outsource payroll duties)

Many employers outsource their payroll and related tax duties to third-party payers such as payroll service providers and reporting agents. Reputable third-party payers can help employers streamline their business operations by collecting and timely depositing payroll taxes on the employer’s behalf and filing required payroll tax returns with state and federal authorities.

Though most of these businesses provide very good service, there are, unfortunately, some who do not have their clients’ best interests at heart. We just received an alert from the IRS advising us that over the past few months, a number of these individuals and companies around the country have been prosecuted for stealing funds intended for the payment of payroll taxes. Hell, Abo and Company has so warned clients for years on this issue. 

We just dug up an Abo and Company 2006 client advisory where we spoke to a then recent tax court opinion which held the taxpayer, Pediatric Affiliates, “…is responsible for supervising the performance of an agent hired to prepare tax returns and make tax payments on the taxpayer’s behalf”.  Here the service bureau, PAL, was Pediatric’s agent and the medical practice was held responsible for the service bureau’s failure to perform, EVEN THOUGH THE SERVICE BUREAU’S MANAGEMENT WAS CONVICTED OF EMBEZZLEMENT AND PERSONALLY USING THE UNREMITTED TAX PAYMENTS.  The Court said that the taxes were, in fact, never paid to the IRS so Pediatric still owed them and the IRS could act to collect them.  Double ouch.

Like employers who handle their own payroll duties, employers who outsource this function are still legally responsible for any and all payroll taxes due. This includes any federal income taxes withheld as well as both the employer and employee’s share of social security and Medicare taxes. This is true even if the employer forwards tax amounts to its outsourced provider to make the required deposits or payments.

Right after this past tax season, we passed along to a number of our clients an April 24, 2013 Wall Street Journal article that stated in the past five years federal officials have prosecuted at least a dozen mostly small payroll firms that together allegedly pocketed more than $300 million in taxes from their clients, according to the IRS tally based on public records.  They commented that roughly 40% of small businesses use outside payroll services for tasks ranging from issuing paychecks to actually paying state and federal employee taxes. Hey, Abo and Company and even most of our CPA colleagues use a payroll service bureau to withhold, report and remit.

Here are some steps Abo and Company, as well as the IRS, suggest an employer can take to protect themselves from unscrupulous third-party payers.

• Enroll in the Electronic Federal Tax Payment System  and make sure the PSP or RA uses EFTPS to make tax deposits. Available free from the Treasury Department, EFTPS gives employers safe and easy online access to their payment history when deposits are made under their Employer Identification Number, enabling them to monitor whether their third-party payer is properly carrying out their tax deposit responsibilities. It also gives them the option of making any missed deposits themselves, as well as paying other individual and business taxes electronically, either online or by phone. To enroll or for more information, call toll-free 800-555-4477or visit www.eftps.gov.

• Refrain from substituting the third-party’s address for the employer’s address. Though employers are allowed to and have the option of making or agreeing to such a change, the IRS recommends that employer’s continue to use their own address as the address on record with the tax agency. Doing so ensures that the employer will continue to receive bills, notices and other account-related correspondence from the IRS. It also gives employers a way to monitor the third-party payer and easily spot any improper diversion of funds.

• Contact the IRS about any bills or notices and do so as soon as possible. This is especially important if it involves a payment that the employer believes was made or should have been made by a third-party payer. Call the number on the bill, write to the IRS office that sent the bill, contact the IRS business tax hotline at 800-829-4933 or visit a local IRS office.

• For employers who choose to use a reporting agent, be aware of the special rules that apply to Reporting Agents (RA). Among other things, reporting agents are generally required to use EFTPS and file payroll tax returns electronically. They are also required to provide employers with a written statement detailing the employer’s responsibilities including a reminder that the employer, not the reporting agent, is still legally required to timely file returns and pay any tax due. This statement must be provided upon entering into a contract with the employer and at least quarterly after that.

• Become familiar with the tax due dates that apply to employers.

While we haven’t seen the IRS so suggesting, for added protection, we often recommend employers ask to see verifiable proof that the provider has some form of fiduciary bond in place to help protect against the service provider defaulting on its obligations.