Articles Posted in Payroll Tax Audits

The Internal Revenue Service (IRS) has released IRS Publication 1779 with guidance for workers to help them determine whether they are employees or independent contractors. Interestingly IRS Publication 1779, which is only two pages does not specifically mention the 20 factor test set forth in IRS Revenue Ruling 87-41, 1987-1 C.B. 296. Instead it groups various factors into three categories-Behavioral Control, Financial Control and Relationship of the Parties. For example under the category Behavioral Control it states that “if you receive extensive instructions on how work is to be done this suggests you are an employee.”

While the publication appears to be aimed at workers rather than employers, an employer could be lulled into a false sense of security by relying on the publication since among other things it fails to mention that even though an employer does not actually exercise control, if the employer maintains the legal right to control the worker those workers may well be employees.

Nor does the publication mention that Section 530 of the Revenue Act of 1978 also known as the “safe harbor rules” allows employers to treat individuals as independent contractors even if they do not qualify under the common law rules. For more information on that topic see our article Independent Contractor Treatment for Workers is Broadly Available.

According to the Government Accountability Office (GAO) the Internal Revenue Service (IRS) hasn’t been doing a very good job collecting payroll taxes. Payroll taxes are amounts that employers withhold from employee wages for federal income taxes, Social Security, and Medicare (so called trust fund taxes) as well as the employer’s matching contributions. The willful failure to pay these payroll taxes is a violation of the criminal tax law, a felony punishable by up to 5 years in jail under Internal Revenue Code (IRC) Section 7602.

The GAO study found that over 1.6 million businesses owed over $58 billion dollars in uncollected payroll taxes. The GAO concluded that the IRS didn’t file tax liens quickly enough, and that it didn’t go after the owners of businesses for the trust fund recovery penalty (TFRP) fast enough. The report also suggested that the IRS wasn’t seizing business assets often enough, pointing out that there were only 667 seizures in fiscal 2007, down from over 10,000 in 1997. The report was a rather scathing indictment of the IRS, and various U.S. Senators were quick to jump on the “bash the IRS bandwagon.” Senator Norm Coleman called on the IRS to “ratchet up its efforts” to recover billions in unpaid payroll taxes, and to hold “tax cheats” accountable.

The IRS responded that among other efforts it is developing and testing streamlined procedures to file injunctions against business with repeat payroll tax problems, and shut them down quickly. Apparently this would include employers whose principals were previously assessed a trust fund recovery penalty, as well as those who have operated multiple entities with payroll tax problems.

Internal Revenue Code § 6672 provides that so-called responsible persons who willfully fail to pay corporate payroll taxes may be held personally responsible for the payment of the trust fund portion of these taxes. Internal Revenue Code § 6672 is sometimes referred to as the trust fund recovery penalty (TFRP). Who is a responsible person? As the court in Horovitz v. United States (WD PA 2008) explained: “responsibility is a matter of status, duty or authority.” The definition of responsible person is not limited to the person with the final say on which bills get paid, but includes others as well.

Horovitz illustrates the principle that more than one person can have liability for the trust fund recovery penalty. The CFO was deemed to be a responsible person since he had the full authority to sign checks, could hire and fire employees, signed payroll tax returns, was a corporate officer, and a 20% owner. The CEO was also held liable for the trust fund recovery penalty since he invested several million dollars in the business, owned 80% of the stock, had unlimited hiring and firing ability and check writing authority, and served as the CEO with day to day involvement in the business.

If you have payroll tax problems, and the IRS is threatening to impose the trust fund recovery penalty contact the Los Angeles, California tax litigation lawyers at Brager Tax Law Group, A P.C.

The California Employment Development Department (EDD) announced that it will be exchanging payroll tax information with the Internal Revenue Service (IRS) . The EDD is the state agency which includes in its duties making sure that employers withhold and payover state payroll taxes. The EDD programs include payroll tax audits of business owners to make sure that all workers who have been treated as independent contractors are truly independent contractors, and not employees. In determining whether workers are properly classified the EDD sometimes relies on the 20 factor test set forth by the IRS in Rev. Proc. 87-41. It also relies on a 9 factor test set forth in the California Supreme Court case set forth in Tieberg v. California Unemployment Insurance Appeals Board (1970), 2 Cal. 3d 943 P. 2d 975; 88 Cal. Rptr. 175. The factors listed are:

1) Whether or not the one employed is engaged in a distinct occupation or business;

(2) The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of a principal or by a specialist without supervision;

The Internal Revenue Service (IRS) ( has reversed its previous lenient policy of allowing the IRS Appeals Division to consider untimely protests of the Trust Fund Recovery Penalty (TFRP). First, what is a trust fund recovery penalty? Actually, its not really a penalty. It’s simply a collection tool that the IRS uses to collect payroll taxes owed by corporations. Under Internal Revenue Code § 6672 the IRS may collect the trust fund portion of the taxes owed by a company from so-called responsible officers who willfully fail to collect or pay over payroll taxes.

The TFRP used to be known as the 100 per cent penalty, but the name probably created too much confusion so it was changed. Before the TFRP can be collected from an individual the IRS must issue a 60 day letter, allowing for a tax appeal to the IRS Appeals Division. In the past IRS procedures provided that even if a protest was filed late it would be forwarded to the Appeals Division for review. See IRM (04-13-2006)

The IRS has issued an internal memorandum which provides that if the tax appeal is not filed in a timely manner than the case will not be heard. It’s definitely not the kinder gentler IRS.

Small businesses which get behind on their debts also often fail to pay their payroll taxes resulting in payroll tax problems for the owners. Not paying payroll taxes is a big mistake since the Internal Revenue Service (IRS) can collect the trust fund portion of the payroll tax debt from responsible officers of a corporation under Internal Revenue Code § 6672. Not all corporate shareholders , however, are necessarily persons liable for trust fund taxes under Internal Revenue Code § 6672. For example, if the payroll tax problems were concealed from the owner he might not be personally liable. Some tax lawyers may have thought that an LLC would provide similar protection for its members, but that’s not always true.

According to the Second Circuit Court of Appeals in New York that’s not the case for a sole member of an LLC. McNamee v. IRS, 488 F. 3d 100 (2nd Circuit 2007). McNamee, who was apparently an accountant (I don’t know whether he was a CPA), represented himself in court, and didn’t have a tax lawyer. McNamee was the sole member of a limited liability company formed under Connecticut state law. Like most states, Connecticut provides that a member of a single owner LLC is generally not liable for its debts.

IRS regulations allow single-owner limited liability company to choose whether to be treated as a corporation–or to be disregarded as a separate entity. If an LLC elects to be treated as a corporation the owner is subject to double taxation–once at the corporate level and once at the individual shareholder level. On the other hand, the LLC may chooses not to be treated as a corporation, either by affirmative election or by the failure to make any election. In the later instance IRS regulations provide that the LLC is disregarded, and that the member is fully liable not just for the trust fund taxes, but all the payroll taxes including interest and penalties accrued on the overdue payroll taxes. The Second Circuit Court of Appeals found that the IRS regulations were valid, and in so doing hit McNamee personally with a large tax debt.

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