Articles Posted in Payroll Tax Problems

The 2007 financial crisis and its aftermath fundamentally changed how Americans think about risk and business. Another effect of the financial crisis was creating a renewed urgency regarding balancing the federal government’s finances. While many in Congress focus on reducing expenditures, the IRS has continued its efforts to increase tax revenues through better identification of tax fraud and tax avoidance even with a decreased budget.

As has been seen in the context of offshore accounts, coming forward voluntarily, making a complete disclosure and taking steps to correct tax problems before the IRS identifies you leads to better outcomes in the majority of situations. If you are concerned that you may have taken overly aggressive positions to minimize taxes that passes through an S Corporation, an experienced lawyer can review your situation and provide peace of mind. If he or she does identify a problem, you can begin taking steps to correct it before being faced with an IRS audit or criminal tax investigation.

What are the tax differences between an S Corp and a C Corp?

Temporary employment agencies have become a more prevalent part of the American work experience since the 2007 financial crisis and the difficult economic times that followed. While on one hand, temporary employment agencies can provide workers with an entry point into a new industry, on the other hand they require payment for their placement services that could otherwise be used to pay the worker a higher wage or to hire additional workers. Furthermore, when the temporary agency acts as the worker’s employer, certain duties and acts are required of the employer. Failure to satisfy these tax duties can lead to criminal prosecution and result in a prison sentence or significant monetary penalties.

How can an employer satisfy their obligation regarding business trust fund taxes?

Trust fund taxes are probably most familiar within the context of how a business withholds payroll tax from its employees’ paychecks every pay period. While the exact deductions on your paystub are likely to differ, commonly found ones include those for federal income tax, Social Security and Medicare taxes (FICA), state and local taxes, and voluntary deductions including an IRA or 401(k).

The 6th Circuit recently taught an expensive lesson to a Michigan couple about carefully following procedure when dealing with tax problems and subsequent loss of their $64,000 refund occurred because of a seeming minor error. Following an IRS tax dispute began, as the IRS’ records stated that the envelope containing the Stockers’ amended 2003 return was postmarked four days late. Compounding the Stockers’ tax problems, the IRS failed to retain the postmarked envelope in question. Seeking help in their tax dispute the Stockers brought suit, but the District Court granted the IRS’ motion to dismiss for lack of jurisdiction due to the suit being barred as past the three-year period for filing a claim for a tax refund. On appeal, the 6th Circuit affirmed.

The 6th Circuit was unmoved by the Stockers’ attempts to prove the mailing date of their return through means other than those set forth in IRC Section 7502. As the IRS’ records indicated that the returns were postmarked four days late, the Stockers could not prove timely delivery under IRC Sec. 7502(a)(1), which states that the postmark of the returns establishes the date of mailing. Additionally, Mr. Stocker’s failure to obtain the certified mail receipt precluded the use of IRC section 7502(c)(1), which states that the “date of registration shall be deemed the postmark date”. The court rebuffed the Stockers’ attempts to prove timely delivery through circumstantial evidence; rather, the Court stated that its own precedent prevented any other method of proof. Finally, the court held that the District Court had not abused its discretion in refusing to draw the inference that the Stockers had timely filed their returns because of the IRS’ failure to retain the postmarked envelope in violation of internal policy.

Despite the seemingly minor nature of the Stockers’ mistakes, the 6th Circuit was highly unsympathetic to their plight. Ultimately, the court reiterated that only certain procedures are available to prove timely filing, and the Stockers’ own mistakes precluded them from receiving relief, despite their innocent nature. While calling it “unfortunate” that the Stockers could not prove the timeliness of their return, the court sent a strong message to taxpayers that it was unwilling to make exceptions for even the most innocent of mistakes.
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In a criminal tax case last year the United States Court of Appeals for the Eighth Circuit upheld the conviction of a man for willful failure to pay the employment taxes of his healthcare staffing business. U.S. v. McClain (8th Cir. 2011). In United States v. Francis Leroy McLain, No. 0:08-cr-00010 (D. Minn. Jul. 20, 2009) the United States District Court for the District of Minnesota determined that Francis McLain knew he should have classified the workers for his temporary nursing staffing agency as employees but willfully chose not to.

How did McLain’s payroll tax problems morph into criminal tax problems? First, he never filed federal payroll tax returns (Form 941) for the periods from the fourth quarter of 2002 through the fourth quarter of 2005 and only made one payment in December 2002 in the approximate amount of $4,200 for employment taxes although the total amount due was approximately $345,000. McClain’s defense was that the nurses were in fact independent contractors and not employees, and even if they weren’t he had a good faith belief that the workers were employees.

The courts were not impressed with McClain’s arguments since he had a history of misclassifying his temporary nursing staff as independent contractors. In a previous civil tax case involving a predecessor company the IRS argued that McClain willfully misclassified his workers and failed to remit the payroll taxes to the IRS. That lawsuit was eventually settled and the IRS obtained a judgment for the unpaid employment taxes, penalties and interest. As a further part of that settlement McLain agreed that “with respect to any other business similar to the … entities that he might own, operate, or control in the future, he would treat as employees for tax purposes all workers who performed functions or duties that were the same or similar as the functions or duties performed by the nurses and nursing assistants who worked for the…entities. In other words, defendant McLain was obligated to withhold and pay over employment taxes for the nursing professionals who worked for any of his entitles.” In addition, McLain did comply with a Minnesota’s statute requiring that nurse staffing agencies like his certify that they are treating their nurses as employees and not independent contractors.

Sometimes it’s a gray area whether to treat workers as employees or independent contractors; but the wrong decision can have detrimental consequences to an employer, and its officers, resulting in large payroll tax liabilities and even tax evasion or tax fraud charges. The IRS has a number of criteria they use in determining whether a worker is an employee or an independent contractor and these federal criteria may differ on a state level as well.
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The criminal tax conviction of a New Jersey couple (the DeMuros) for failure to pay payroll taxes to the IRS was affirmed by the Third Circuit Court of Appeals, United States v. DeMuro (3d Cir. 2012). The willful failure to pay payroll taxes is a violation Internal Revenue Code (IRC) Section 7202, and is punishable by up to five years in prison. Of course the willful failure by a responsible officer to pay trust fund taxes is also a violation of IRC Section 6672, and will result in a trust fund recovery penalty (TFRP) being assessed against the responsible officers. Obviously the criminal tax conviction is much more serious than the assessment of the trust fund recovery penalty.
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The DeMuros failed to pay trust fund taxes for their business of more than $546,000 over 21 calendar quarters from 2002 to 2008, resulting in a 21 count indictment. While that is a lot of money it is easy to see how a failing business could wind up in that situation since it amounts to about $25,000 per quarter, and was spread over a seven year period. A large sum, but not shocking, at least not to tax lawyers, and other tax professionals who see this type of underpayment on a semi-regular basis.

The DeMuros tried to argue that their failure to pay wasn’t willful, but to no avail. The IRS pointed to evidence that during the same time period the DeMuros spent over $5 million dollars from their personal and corporate bank accounts. Apparently several witnesses testified at trial about the DeMuros “luxury vacations, nice homes, and [Mrs. DeMuros] substantial home shopping network expenditures,” and the DeMuros argued on appeal that the admission of this evidence was “prejudicial.” The response from the Third Circuit was: “[w]hile we are sensitive to the effect that evidence of a defendant’s liberal spending habits can have on a jury, particularly in these lean economic times, the evidence admitted in this case, i.e. evidence of vacations, jewelry, cars and parties, was not so inflammatory as to carry a great risk of prejudice.”

Mrs. DeMuro argued at trial that she was not responsible for paying the payroll taxes. The IRS response was to show that that Mrs. DeMuro had the authority to fire employees and signatory authority over corporate bank accounts.

Interestingly the IRS also called as a witness the Enrolled Agent that represented the DeMuros before the IRS with regard to the payroll tax problems. The Enrolled Agent testified that he had reviewed two appeals that the DeMuros had filed, and that in his opinion they were meritless, and therefore should have been withdrawn. Advice which apparently the DeMuros didn’t follow, and the IRS relied on this as evidence of bad faith on the part of the DeMuros.
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Last month, while most people were preparing their Christmas lists, Louis Alba, a New York contractor, plead guilty to criminal tax charges of failing to pay over to IRS employment taxes withheld from employee wages in the amount of almost $780,000 over approximately six years. Failure to pay over payroll taxes is considered a felony under Internal Revenue Code (IRC) Section 7202. It is punishable by up to five years in jail, and a fine of up to $250,000.
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In the current economic environment business owners who are strapped for cash sometimes decide to “borrow” from the IRS by not paying the payroll taxes. The theory is that if cash is tight, and the vendors aren’t paid there will be no more merchandise to sell, and therefore the business will go under quickly. The same with the landlord; don’t pay the rent, and one can expect an eviction notice in short order. The IRS on the other hand moves slowly, and the temptation is to believe that if you have another 6 months or so business will turn around, and the IRS can be paid back.

Unfortunately in many cases that doesn’t happen. The IRS doesn’t look on this as borrowing; it views the failure to pay payroll taxes as stealing. Even if criminal tax charges are not brought, so-called responsible officers who fail to pay over corporate payroll taxes can be held personally liable under IRC Section 6671. More and more, however, the IRS is bringing criminal tax fraud charges. For the record persons convicted of tax crimes still must pay the taxes. It’s not one or the other.
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The IRS has filed felony criminal tax charges pursuant to Internal Revenue Code Section 7202 for willful failure to collect, truthfully account for and pay over trust fund taxes. This is yet another in a series of criminal tax charges being brought against responsible officers who haven’t paid over corporate trust fund taxes. In most situations the IRS proceeds against responsible officers who willfully fail to pay corporate trust fund taxes, by assessing the tax directly against the individual under Internal Revenue Code Section 6672. This is generally referred to as the trust fund recovery penalty. Sometimes the IRS goes further and brings criminal tax charges. paper_work.jpg

In this case the defendant is a New York CPA who, according to the information filed in U.S. District Court, failed to pay payroll taxes to the IRS for three years running. Our tax lawyers found this case interesting because the amount of unpaid trust fund taxes was not terribly large. The total the IRS alleged as unpaid was approximately $108,000, fairly small potatoes, as payroll tax cases tend to go.

I thought it was important to blog about this case because clients sometimes assume that the relatively small size of their tax problem will insulate them against criminal tax liability. While that is generally accurate, as this case illustrates, not always.
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United States v. Quinn (D. KS 2011) is one of several recent felony tax prosecutions, not for tax evasion, but for violation of Internal Revenue Code Section 7202. IRC Section 7202 makes it a felony to willfully fail to collect, account for, or pay over any tax due. In this case Ms. Quinn failed to pay payroll taxes for 7 quarters between 2003 and 2005. She finally got around to paying them in 2010, apparently after the IRS had filed criminal tax charges against her. Ms. Quinn challenged the finding that she failed to pay employment and individual tax and argued that since she had subsequently paid the tax due the charges should be dismissed.old_ball_and_chain.jpg

The court wrote in its opinion that a person has failed to pay taxes if they have not paid the amount due as of the due date, regardless of whether the taxpayer has subsequently paid. In Ms. Quinn’s case, she had recently paid the amounts due but this was not sufficient for the court to find her not guilty.

This does not mean that late payment of taxes will never prevent a criminal tax prosecution, and those who have not paid their taxes should seriously consider taking care of a tax problem before it turns into a criminal tax problem. Had Ms. Quinn gotten around to making full payment, or indeed even made good faith installment payments much earlier there is a chance that the case would never have gotten as far as it did.
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Criminal tax charges were recently upheld by the Sixth Circuit Court of Appeals against an individual who withheld payroll taxes but failed to pay those amounts over to the Internal Revenue Service (“IRS”). The defendant had been convicted of fifteen counts of Failure to Account for and Pay Over Withholding and FICA Taxes, in violation of 26 U.S.C. § 7202, and three counts of Making and Causing the Making of a False Claim for a Tax Refund, in violation of 18 U.S.C. § 287. The lower court sentenced the defendant in the case to 22 months in prison and 36 months of supervised release and ordered him to pay the amount owed plus penalties.

The defendant in the case, Richard Blanchard, did not pay trust fund taxes for approximately 6 years despite withholding taxes from his employees. The case started out as a civil tax audit, but then it became a criminal tax case. Blanchard appealed the decision of the district court, stating that the government failed to prove that he was financially able to pay over the employment tax and that the government must do so in order to show that his failure to pay violated the relevant statute. The appellate court found not only that the government did not need to prove that Blanchard was able to pay the tax, but also that Blanchard’s inability to pay that tax would not even constitute a defense to the government’s accusations. The court cited previous cases and stated that every individual must conduct his financial affairs in such a way that he is able to pay his tax liability when it becomes due. Thus, Blanchard’s conviction and sentence of 22 months plus 36 subsequent months of supervised release were affirmed.

The case is disturbing to the extent that it brings to mind the concept of debtors prison. Business owners need to understand that failure to pay withheld tax over to the IRS may result in criminal tax fraud charges as well as civil tax penalties.
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A Kansas woman will still face federal criminal tax charges for failure to pay payroll taxes after a federal court ruled the charges should not be dismissed simply because the taxes have since been paid.

As tax litigation attorneys we frequently hear from clients who have been contacted by the IRS criminal investigation division. Their first reaction is, “I will get the taxes paid can you get the IRS to drop the charges?” Unfortunately at that point simply paying the taxes will rarely solve the problem by itself. Payroll taxes cases usually turn criminal because the tax problem has been ignored for far too long.


In this case, the employer was charged with seven counts of failing to pay over trust fund taxes (income taxes and FICA), which had been withheld from employees’ pay. The tax violations allegedly occurred between 2003 and 2005. She submitted evidence in 2010 that she had turned over to the Internal Revenue Service all unpaid taxes. She argued the charges should be dismissed since the taxes had been paid.

The government argued payment did not “cure” her of the violations or immunize her from prosecution. It was a novel legal question not addressed in case law. Section 7202 of U.S. tax law states: “Any person required under this title to collect, account for, and pay over any tax imposed by this title who willfully fails to collect or truthfully account for and pay over such tax shall . . . be guilty of a felony. . . .”

The defendant noted the law makes no reference to a “due date” or other time frame. Section 7203 does make reference to a time frame when it states “at the time or times required by law or regulations.”

The court ruled that the statute’s wording “failure to pay over” necessarily encompasses late payments by any common sense standard. Additionally, the court ruled the defendant’s interpretation of the law would make it the only area of criminal law in which a crime could be undone at any time until conviction.

The defendant was also charged with two counts of failure to pay individual income taxes, which were not addressed in the court decision.
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