Civil Contempt and Employment Taxes

I.R.C. Section 3111

The United States District Court for the Southern District of New York ruled in USA v. Jiffy Cleaners of Hartsdale, Inc. and Wilton Calderon at case number 16 CV 2428 (VB) filed July 27, 2020, that civil contempt requested by the Government was appropriate since a prior judgment for $110,853.48 was clear and unambiguous setting forth the taxpayer’s responsibilities regarding making employment tax payments and the government sufficiently detailed taxpayer’s noncompliance. The taxpayer operated a dry cleaning business. The government alleged that the taxpayer failed to pay over employment taxes and opened a court case to collect. One of the owners of the business was present in court when a judgment was entered ordering them to pay the government for monies owed, timely file and pay current returns. Further, the judgment enjoined the taxpayer from assigning or transferring money or assets to any other person or entity. Monthly affidavits were to be delivered to the IRS to substantiate compliance.  A short time later, the spouse of the owner incorporated a business to operated as a dry cleaners one mile away. The original business was closed. The IRS learned that certain equipment had been transferred from the old business to the new one. The government contended that the taxpayer had not complied in many ways, one of which was transferring property. Additionally, they failed to pay current taxes and file returns from the time of judgment to shut down of operations. The taxpayer made what the Court deemed to be a handful of frivolous arguments. Ultimately, the Court deemed the taxpayers to be in contempt. The Court entered an order prohibiting the owner from occupying any position within any business for which he would be responsible for collecting, truthfully accounting for, paying, withholding, or filing any taxes pursuant to the IRC, including employment taxes. 

IRS institutes Early Interaction Initiative for Employment Tax matters

IRS institutes Early Interaction Initiative for Employment Tax matters

  It is expected that the IRS will be instituting swifter action against employers that are falling behind on their Federal Tax Deposits (FTD’s) for employment taxes.  Those taxpayers who have had interaction with a field Revenue Officer are likely hearing from those Revenue Officers more quickly if they fall behind on their required deposits.  However, the IRS announced in December 2015 that it is instituting efforts to identify employers who appear to be falling behind on their tax payments – apparently even before their employment tax return is being filed. 

            The IRS has indicated that their identification efforts will result in letters, automated phone messages, and other communications which could include a visit from a field Revenue Officer.  The IRS has indicated that this effort will reduce the likelihood of the problem becoming uncontrollable.  Many taxpayers simply do not realize how steep the penalties can be for failure to properly make tax deposits, pay employment taxes timely, or failure to file timely returns.  Further, it is unlikely that most taxpayers understand the personal liability that can be assessed from unpaid employment taxes.  A liability that is not dischargeable in bankruptcy.

            While the education efforts are beneficial, certainly there is an enforcement aspect of this activity by the IRS.  The IRS readily admits that two-thirds of federal taxes are collected through the payroll tax system.  With a reduced budget, this activity makes good sense for the IRS.  However, it is most likely going to be most burdensome for small businesses. 

            No doubt early action is best.  If you know you have been falling behind on your payroll tax obligations and need assistance planning before you hear from the taxing authorities, feel free to call. 

Texas Receives “High Performance Bonus”

Texas Receives “High Performance Bonus” Under Federal Worker Misclassification Initiative:

The U.S. Department of Labor (DOL) recently awarded $10.2 million in grants to 19 states as part of the Department’s Misclassification Initiative. The Misclassification Initiative was created in 2011, as part of a Memorandum of Understanding (MOU) signed between the DOL and IRS.  The MOU formed an agreement between the two agencies to work together to reduce the incidence of worker misclassification, by sharing information and coordinating enforcement efforts.

A worker misclassification occurs when an employer or business owner classifies a worker on their tax returns as something other than an employee (such as an independent contractor), when they should be classified as an employee. Generally, the distinction between an employee and independent contractor is in how much control the person paying for the service has over (1) what work will be done and (2) how that work will be done. The more control the person paying has over the work being done, the more likely it is that the person providing the service should be classified as an employee.

From the worker’s perspective, misclassification can mean denial from benefits and programs such as family medical leave, overtime, minimum wage, and unemployment insurance. From the government’s perspective, misclassification leads to a substantial loss to the Treasury by way of lost Social Security, Medicare, unemployment insurance, and worker’s compensation funds.

While the Misclassification Initiative was started in 2011, this year is the first year that individual states were eligible to receive grant funding for their efforts to decrease worker misclassification. Although several states already had existing programs designed to reduce misclassification, under the federal Misclassification Initiative individual grants up to $500,000 were awarded to 19 states under a competitive award process.

The Misclassification Initiative also offers additional grant funding to states through its “High Performance Bonus” program.  This bonus program is based off the Federal Supplemental Nutrition Assistance Program (SNAP), formerly called the food stamp program, which also provides bonuses for high performing states. So far, four states (Maryland, New Jersey, Texas, and Utah) have received such bonuses. Of those states, Texas has received $775,529 in bonuses, which is almost $300,000 more than the next highest recipient, New Jersey. According to the DOL the bonuses are awarded to the states that are most successful in detecting and prosecuting employers that fail to pay taxes due to misclassification. The bonus program is designed to give states both an extra incentive to carry out enforcement actions and additional funds to upgrade their misclassification enforcement programs.

If you’re unsure how your workers should be classified and would like assistance, please contact our office.

Professional Assistance With Long-Term Tax Delinquencies Can Be Key To A Turn Around

If you have experienced a continuing struggle with handling your ongoing employment and income tax filings and payments, you may be facing the stark reality that managing these obligations is getting more and more difficult.  Some businesses have operated off the premise that the federal and state government will perpetually respond to their tax problems in a certain way.  That response by the government, through a series of notices, delayed responses, and payment plans, is changing faster than ever.  This is especially true at the state level.  Businesses should not make what was once predictability of tax collections by the government a part of how they manage their ongoing business expenses.

While the government may not upgrade their technologies as quickly as the private sector, the actions being taken are making a difference in closing the Tax Gap. This is true at the federal level and even more so at the State level.  As Bloomberg Business Week reports, states are taking much more aggressive action to capture lost sources of tax revenue.  States are using better resources of data collection along with other enforcement tools to prevent businesses, large and small, from operating in a non-compliant tax status.

From a business perspective, the stark reality is that there are some businesses on the fringe of existence that may simply be forced to cease operations as the tax collection activity described here intensifies.  It’s my opinion that this is not necessary.  Rather, if these businesses spend less time juggling some of these obligations and direct their time towards the expertise they have related to their primary business function, their likelihood of success is much greater.  We have seen the most success for clients who have long-term tax delinquencies when that client acquires proper legal and accounting assistance.  For a long-term problem, a long term solution is necessary. 

Certified Public Accountants and other tax return specialists can provide a level of service that is invaluable to any business.  Assistance from a tax lawyer can be an important tool which allows for a delinquent taxpayer to create a long term plan for tax debt resolution which is then executed upon by the taxpayer, its accountant and lawyer.  Most clients find that the support of professionals that can readily provide expert guidance on stressful tax matters are invaluable.  The relief provided to the business owner typically gives them the breathing room they finally need from a stressful situation to focus on the reason they entered their business to begin with.  It is highly rewarding for the tax lawyer and accounting professional to observe this process.  No business operation will ultimately succeed with the passion of its owners for the services or products it provides. 

As a tax lawyer I have observed that the combination of a Certified Public Accountant or other tax return professional with the guidance of a tax lawyer is a highly beneficial combination for a delinquent business taxpayer.  The reality is that the Certified Public Accountant or tax return professional likely has all the expertise to resolve these issues, but due to the reality of the tax season, that person lacks the time to provide the level of assistance demanded from a Revenue Officer or other collection agent.  Without the obligations of providing return preparation services for clients, I have found the ongoing demands of dealing with delinquent tax matters for clients to be manageable. 

Ideally, the long term is a viable business with a plan to manage ongoing tax obligations while addressing delinquencies in a manner that does not effectively shut down the business.  Once that plan is in place, the taxpayer’s Certified Public Accountant or return preparation professional can provide services to manage current tax filing and payment obligations.  Should the government return for review of the client’s ability to address the tax delinquencies, the tax lawyer can return to representation to assist with that issue. 

As a business owner with a long term delinquency a critical perspective to have when acquiring professional assistance is that there is no “quick fix.”  A multi-year problem will likely take many months, if not years, to resolve.  But it can, and does, happen.  Feel free to contact us to discuss these issues if you have them.

Trust Fund Recovery Penalties

Certain situations can place an individual at risk of personal assessment for business related taxes, including employment taxes and withheld income taxes.  Congress created the Trust Fund Recovery Penalty to discourage misuse of employee’s tax dollars.  An employer is technically expected to set aside income taxes along with Social Security and Medicare taxes in trust for the benefit of the government.  Ultimately, the employer also pays Social Security and Medicare taxes and submits all taxes to the IRS with the employment tax return.  A willful failure to collect or pay over the taxes by a responsible person could result in an assessment of the Trust Fund Recovery Penalty. This penalty equals 100% of the unpaid income tax withheld, plus the employees withheld Social Security and Medicare taxes.

 If the business owner is the individual assessed with this penalty, it is important to note that the penalty is a separate assessment from the employment tax of the business.   Legally, the IRS could collect both, but as a matter of policy the IRS does not. However, it is entirely possible for the IRS to collect on both debts at the same time, requiring the individual and the business each to come into some form of compliance with a payment agreement or other arrangement.  The IRS policy merely means that the IRS will not collect more than the total employment tax owed by the business.

 In order for the government to assess this penalty, it must substantiate that a person is both responsible for collecting and paying over the taxes withheld to the government and that the person responsible willfully failed to collect or pay these taxes.

 When examining a delinquent business taxpayer, the IRS will look for any and all responsible parties – their analysis does not necessarily focus on a single individual.  A responsible person is a person, or group of people, who has the duty to perform and the power to direct the collecting, accounting, and paying of trust fund taxes. This person may be:

  • an officer or an employee of a corporation, or limited liability company
  • a member or employee of a partnership
  • a corporate director or shareholder
  • a limited liability company manager or member
  • a member of a board of trustees of a nonprofit organization
  • another person with authority and control over funds to direct their disbursement, or
  • another corporation or third party payer

As this list indicates, it is not simply the owner of the business that is at risk for assessment.

 The IRS describes responsibility as a matter of status, duty, and authority. A determination of responsibility is dependent on the facts and circumstances of each case. A responsible person has:

  • A duty to perform
  • Power to direct the act of collecting trust fund taxes
  • Accountability for and authority to pay trust fund taxes
  • Authority to determine which creditors will or will not be paid

The United States Tax Court has ruled that a person can still be held responsible even if he or she has delegated a duty to someone else.  And the Court has ruled that a person may be responsible even though he did not know that the withheld taxes were not being paid over to the government.

 There are certain factors that the Courts have looked at as indicators that a person is likely a responsible person. Here are some examples:

  • Holding the position of an officer or member of the board of directors
  • Having a substantial ownership interest in the business
  • Having the authority to hire and fire employees
  • Managing the day-to-day operations of the business
  • Deciding how to disburse funds and pay creditors
  • Possessing the authority to sign checks or authorize payments on behalf of the business.

Just because a person is responsible, doesn’t mean that they can be assessed.  It is necessary to show that the person acted willfully in failing to collect or pay over the trust fund taxes.  Several Courts have ruled that willfulness does not require a criminal or other bad motive. Rather, the Courts have indicated that a voluntary, conscious and intentional failure to collect, truthfully account for, and pay over the taxes withheld from the employees is enough to be deemed willful for this purpose.  A responsible person acting with a reckless disregard of a known or obvious risk that trust fund taxes may not be remitted to the Government will be deemed willful.  Merely acting negligently however is not enough to meet the required standard of acting willful.

 If you are put in the position of potentially being assessed with a trust fund recovery penalty, you should be aware that the proposal to assess you does come with appeal rights.  If the IRS employee proposing assessment believes you are responsible and acted willfully, you may administratively appeal this proposal to the Appeals Division of the IRS for review. During the appeals hearing, you have an opportunity to show why you were either not responsible or not willful.

 If you lose on appeal, or do not appeal the proposed assessment, the liability is assessed and the IRS will proceed with collection of this debt no differently than any other personal liability.

 If you are undergoing evaluation as a proposed responsible person for assessment of a Trust Fund Recovery Penalty, or if you need assistance with the Appeal of a proposed penalty or avoidance of collection action for an assessment of a trust fund penalty, do not hesitate to contact our office for further assistance.

Voluntary Classification Settlement Program

Expansion and Temporary Changes

The Internal Revenue Service has recently issued guidance expanding eligibility for taxpayers to qualify for the Voluntary Classification Settlement Program (VCSP). In addition to the expanded qualification guidelines, the IRS is temporarily removing a key requirement for acceptance into the program that could provide many employers with a valuable opportunity to reclassify its workers with very limited federal employment tax liability for prior nonemployee treatment. The temporary relief is associated with taxpayers who have failed to properly issue 1099’s to their workers.

The VCSP has been critical given the aggressive nature of worker reclassification at the state level. Many states are seeking to close the gap on unemployment benefit contributions paid by employers versus unemployment benefit payments paid to workers. As the states have had to borrow from the federal government, they have many times incurred additional costs and interest to do so. Several states have increased program activity associated with the recharacterization of 1099 workers to employees. Of course, the contributions to the state unemployment office for re-characterization may not be terribly burdensome, but recharacterization by the IRS becomes much more likely after a state audit and paying inappropriately withheld income taxes, Social Security and Medicare taxes, may very well be too burdensome for the average small business.

The objective of the IRS as set forth in Announcement 2012-45 is to “facilitate voluntary resolution of worker classification issues and achieve the benefits of increased tax compliance and certainty for taxpayers, workers and the government.” In order to expand the program, the IRS has modified it by adjusting the following items:

1) The IRS will now permit a taxpayer under IRS audit, other than an employment tax audit, to be eligible to participate;

2) Clarified guidance that a member of an affiliated group is not eligible to participate in the program if any member of the affiliated group is under an employment tax audit by the IRS;

3) Clarified that a taxpayer is not eligible to participate in the VCSP if the taxpayer is contesting in court the classification of the class or classes of workers from a previous audit by the IRS or Department of Labor; and

4) Eliminated the requirement that a taxpayer agree to extend the period of limitations on assessment of employment taxes as part of the VCSP closing agreement with the IRS.

IRS Announcement 2012-46 temporarily expands eligibility for the program until June 30, 2013. One of the requirements of the existing program is that all 1099s were to have been properly filed for the previous three years with respect to the workers to be reclassified. Many times, this prohibited the taxpayer from qualifying for the program. As such, the IRS will temporarily eliminate this requirement and allow taxpayers who have not complied with 1099 filing requirements to qualify for the program.

If the taxpayer qualifies but is not compliant with 1099 requirements, the taxpayer will pay a greatly reduced employment tax liability for reclassified workers based on the prior year’s compensation. Additionally, the taxpayer will pay a reduced penalty for unfiled Forms 1099 for the prior three years with respect to the workers being reclassified. There will not be any interest or penalties otherwise calculated.

The potential savings from this program along with the certainty it provides are well worth the effort to explore whether or not the taxpayer qualifies. If you require any assistance with a review or submission of an application for the VCSP please do not hesitate to contact our office.

Understanding the Voluntary Classification Settlement Program

Has your business recently undergone an examination by the state unemployment office?  Did that examination result in independent contractors being recharacterized as wage earners? If so, you likely are facing a new tax debt for unpaid unemployment contributions with the state agency.  Many businesses are finding themselves in this situation.  However, the problem does not end there. The recharacterization will be shared with the federal government, and the IRS will also assess a new debt for unpaid Social Security, Medicare, and income taxes for these employees.  
If your business has concerns about the status of independent contractors, there is an opportunity to be proactive and avoid the problems of federal reclassification by examination. Additionally, you can dramatically reduce the overall debt owed to the federal government.  The Voluntary Classification Settlement Program (VCSP) was created by the IRS to resolve worker classification issues and provide certainty to taxpayers.
The basic concept of the program is simple:  if a business is willing to voluntarily reclassify independent contractors as employees, then the IRS will allow the business to pay a greatly reduced amount for  any unpaid Social Security, Medicare, and income taxes for previous periods.  The important point is that the business will be required to pay all Social Security, Medicare and income taxes for all future periods after the reclassification has been completed.
When a business applies to the VCSP, the IRS will calculate a fee equal to approximately 1% of the amount paid to reclassified workers in the last calendar year.  No further assessment will take place by the IRS if accepted into the program and the employer begins treating the reclassified workers as W-2 employees.
This program has very specific criteria. However, the program is broadly available to businesses, not for profit entities, and governmental entities. In order to be accepted in the program, the taxpayer must meet the following criteria: 

  1. The taxpayer must want to voluntarily reclassify certain workers as employees for federal income tax withholding, Federal Insurance Contributions Act (FICA), and Federal Unemployment Taxes for future periods;
  2. The employer must be treating the workers as non-employees;
  3. The employer must have satisfied any 1099 requirements for each of the workers for the 3 years preceding the calendar year ending before the date the request for reclassification is submitted. If the worker didn’t work for the employer for the entire three year period, this requirement is met if the Form 1099 has been issued to the worker for the time period he or she did work for the employer;
  4. The employer must have consistly treated the worker as a non-employee. In other words, a business cannot reclassify a worker who is on a 1099 if that worker was provided a W-2 in a prior year;
  5. The employer must have no dispute with the Internal Revenue Service as to whether the workers are non-employees for federal employment tax purposes;
  6. The employer cannot be currently under examination by the IRS;
  7. The employer must not be under examination by the Department of Labor or any state agency for the proper classification of the worker. This is key a point—if the issue was brought to the taxpayer’s attention by a state unemployment agency, the taxpayer will want to apply for this program after the conclusion of the state examination, but before receiving a notice from the IRS that the taxpayer is subject to a federal audit!
  8. The taxpayer must not have been previously examined by the IRS or the Department of Labor for the classification of worker, or if the taxpayer has been examined previously by either entity, then the taxpayer must have complied with the results of the prior examination.

 Finally, there is a provision of the agreement that extends the statute of limitations for assessment of employment taxes for three years for the first, second, and third calendar years beginning after the date the taxpayer elects to begin treating the workers as employees under the program.
 The good news is that there is a high level of certainty upon completing this program. Once the proper form is submitted to the IRS, the IRS will review the request and if accepted, enter into a closing agreement with the taxpayer.
 To put the importance of this program into perspective, if an employer requested reclassification of workers previously reported on Forms 1099 that totaled $200,000 in the prior calendar year, and the IRS accepted the employer into the program, the employer would pay a fee of approximately $2,000 to address the periods of questionable classification. Absent this program, the employer would pay $26,600 in delinquent Medicare and Social Security taxes alone! This amount would also be increased by unpaid employee income taxes, penalties, and interest.
 The Voluntary Classification Settlement Program is part of the IRS Fresh Start program and a wonderful window to avoid burdensome delinquent taxes, penalties, and interest. If you have questions about the VCSP, please feel free to contact our office to learn more.