About 8,000 employees and 400 small businesses were negatively impacted by the collapse of a company called MyPayrollHR the fall of 2019 while it was under investigation for payroll theft and tax fraud.
MyPayrollHR was a third-party payroll service provider (PSP) responsible for processing employee wage and tax payments on behalf of employers. The company’s former president, Michael Mann, had diverted payroll taxes—including federal and state income tax withholding and FICA tax payments—into accounts he controlled, which means the victimized employers need to make up those missing payments.
In mid-August, Mann pleaded guilty to 12 criminal charges, including nine counts of bank fraud, wire fraud and identity theft. Prosecutors accused Mann of defrauding banks and other financial institutions as well as his company’s employer clients. He is expected to be sentenced in December, but it is not expected that he will be able to make restitution of the $101 million he stole.
Given the complexity of today’s tax and wage laws, it’s hardly surprising that many employers have chosen to shift their responsibilities in this area to PSPs. However, given cases like that of MyPayrollHR, the IRS warns business owners they need to be careful who they select to perform these services and monitor them regularly.
Most PSPs are careful in fulfilling their responsibilities but given the right circumstances it’s not that unusual for some to violate their fiduciary duties. When they do so, it can result in a failure to deposit employment taxes, which then makes the employer liable for the unpaid payroll taxes as well as any interest and penalties that can accrue.
Employees who are caught up in the MyPayrollHR mess should not be concerned about additional tax consequences beyond the delay in receiving their pay, according to attorneys S. Michael Chittenden and Marianna G. Dyson of the law firm of Covington & Burling. They are protected from the consequences of diverted payroll taxes because they are entitled to a credit against their personal income tax regardless of whether the Treasury Department received the withheld taxes.
“The key takeaway is that employers will not automatically be absolved of the tax obligations on wages paid to their employees because of the illegal acts committed by third-party agents,” the attorneys explain. “Employers should proactively take steps to ensure payroll deposits are being timely made by their payroll service provider. If the employer discovers late or missing deposits, steps should be taken to deposit promptly any late taxes in an effort to avoid or mitigate any potential penalties.”
IRS Issues Warning
The IRS does not regulate PSRs; however, it can help employers protect themselves in other ways. The agency recently issued a detailed warning for employers who rely on PSRs to follow, including steps they can take to monitor tax payments.
IRS Commissioner Chuck Rettig says, “A business doing everything else right can suddenly find its future in doubt if it falls victim to an unscrupulous third party that fails to make the required payroll and withholding deposits. We want to encourage all employers to understand their obligations and choose wisely when it comes to selecting a trusted payroll service to carry out this critical function. This is especially important right now as businesses face unique challenges because of the pandemic.”
Eric Hylton, commissioner of the IRS, Small Business/Self Employed Division, observes, “Most third-party payroll services do a good job helping small businesses meet their deadlines and payroll obligations, but each year some employers fall prey to unscrupulous third-parties that fail to send the IRS the taxes entrusted to them. We are vigilant in pursuing these third parties, but too often their clients—the employers—are left on the hook. The IRS wants all employers to take the necessary steps to protect themselves.”
As is the case with the employers who handle their own payroll duties, IRS makes it clear that employers who outsource this function are in most instances still legally responsible for any and all payroll taxes due. These include any federal income taxes withheld as well as both the employer and employee shares of Social Security and Medicare taxes.
This also is true even if the employer has forwarded tax amounts to the third party to make the required deposits or payments.
IRS says that one third-party arrangement that can reduce this risk is the certified professional employer organization (CPEO). Unlike other third parties, in most circumstances, the CPEO is solely liable for paying the customer’s employment taxes, filing returns and making deposits and payments for the taxes reported with regard to wages and other compensation it pays to its employees.
Those kinds of PSPs—who also are deemed registered reporting agents (RAs)—have informed IRS of their relationships with particular clients (via Form 8655, Reporting Agent Authorization, which is signed by the client). The RA is required to deposit its client’s taxes via the Electronic Federal Tax Payment System (EFTPS) and is authorized to exchange information with the IRS on behalf of its client in cases where an issue needs to be resolved.
For an overview of how the roles and obligations of PSPs, reporting agents and CPEOs differ from one to another, see the Third-Party Arrangement Chart on IRS.gov.
How to Protect Yourself
The IRS urges employers to take the following steps to protect themselves from unscrupulous third parties:
Enroll in EFTPS 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 PSP or RA is properly carrying out its tax deposit responsibilities.
It also gives employers the option to make any missed deposits themselves and allows them to pay other individual and business taxes electronically, either online or by phone.
Understand that the employer, not the RA or PSP, is ultimately liable for the timely filing of returns and payment of taxes. RAs are required to deposit clients’ taxes via EFTPS and, with limited exception, electronically file the tax returns. They also are required to provide clients with a written statement reminding the employer that it, not the reporting agent, is ultimately responsible for the timely filing of returns and tax payments.
This statement must be provided when entering into a contract with the employer and at least quarterly after that. See Reporting Agents File for more information. If the PSP fails to make the federal tax payments, the employer is liable for any taxes, penalties and interest due. The IRS may also choose to file liens and issues levies against the employer.
Refrain from substituting the third party’s address for the employer’s address. Although employers are allowed to agree to such a change, the IRS recommends an employer continue to use its 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 and easily spot any improper diversion of funds.
Report PSP fraud. If an employer suspects its PSP of improper or fraudulent activities involving the deposit of federal taxes or the filing of returns, the employer can file a complaint using Form 14157 Complaint: Tax Return Preparer. Once received, PSP-identified complaints will receive expedited handling and investigation, the IRS promises.
“Employers should remember to watch out and do due diligence to help safeguard themselves—and their employees—from a payroll service provider failing to do what the law requires,” Rettig stresses.
Don Fort, chief of IRS Criminal Investigation, also states that his unit “is committed to investigating all tax criminals, especially professionals who have fiduciary responsibilities and violate the trust of their clients. Those parties who do violate that trust may go to jail, but the defrauded employer’s problems are just beginning.”
Fort adds, “There is no substitute for continued diligence in ensuring something so important is done right. Your employees are counting on you.”