An Overview of Employment Taxes

Whether as employee or employer, taxes are a permanent workforce expectation. But let’s first go over what we already know. Employers must withhold and pay employment taxes over to the Internal Revenue Service (IRS). Those taxes include federal income tax, social security, Medicare, and unemployment taxes. Despite all the grumbling, these taxes provide important benefits to employees who pay into these federal programs. Here is a rundown:

• Social security: Disability, survivors, and old age benefits are accrued by employees when they pay their social security taxes.
• Medicare: Hospital and medical benefits are funded by the Medicare program.
• Unemployment taxes: For workers out of a job, unemployment taxes can offer a lifeline of benefits and services.
• Federal income tax: Federal taxes taken at the paycheck level ensure federal income withholding amounts are tallied and paid as earned. 

Collectively known as “employment taxes,” these monies can be easy pickings for business owners awash in red ink or looking to live beyond their means by keeping, rather than paying, these taxes.

Why Paying Taxes is Important

A recent report from the IRS shows about the same number of us are paying the taxes we owe, and about the same number are not.

The tax gap, or the difference in taxes paid versus those potentially owed (as estimated by the Internal Revenue Service) in the United States, is about $381 billion, according to the latest estimates. Those billions are monies that would fund a myriad of worthwhile programs and services throughout the country—were they paid as per federal tax laws.

In September of 2019, the IRS released its comparative report that looked at tax revenue in the years 2011 through 2013. There are five types of taxes reviewed by the IRS. These taxes include employment taxes, personal income taxes, corporate taxes, excise, and estate taxes. The bottom line is that the tax gap is roughly the same as it was during tax years 2008 through 2010. In this same report, it estimates that about 83.6 percent of owed taxes are paid on time and voluntarily by U.S. taxpayers. By comparison, the percentage of taxes paid the same way in the 2008 to 2010 tax period was 83.8 percent—virtually the same. 

Notes IRS Commissioner Chuck Rettig, "Voluntary compliance is the bedrock of our tax system, and it's important it is holding steady. Tax gap estimates help policy makers and the IRS in identifying where noncompliance is most prevalent. The results also underscore that both solid taxpayer service and effective enforcement are needed for the best possible tax administration."

The tax gap is divided into three ways:

• Taxes that are underpaid: These are taxes that are reported, but not paid on time.
• Taxes that are underreported: These are revenues that are understated on a tax return.
• Taxes that are not filed: As the name implies, these are taxes that are not paid on time, nor are required tax returns filed on time.

Tax gap estimates are an important measure of compliance in the U.S. Compared to many countries, the U.S. enjoys a relatively high and stable rate of tax compliance. While most people are interested in saving on their taxes or seeing tax rates reduced, tax revenue pays for necessary state and federal services. Without tax infrastructure, even basic expectations, like passable roads, good education, food safety, affordable utilities, and federal security, can quickly go south.

Despite the budget squeeze at the IRS, the agency continues to push compliance through its criminal tax investigations and civil and criminal tax audits. That said, no one needs to pay more tax than is legally owed, and there are smart strategies you can use to pay tax obligations, report wealth accurately, and protect individual or corporate wealth from unnecessary taxation. 

What Constitutes a Tax Crime?

You or your company might underreport your income a little. Maybe you don’t reveal all of your foreign holdings on your FBAR. Or, maybe you cooked up a scam over a few years that finds you claiming deductions you have no hope of being able to support. Are you going to jail?

Though it’s true that the number of IRS prosecutions for tax crimes has declined. But is the IRS aiming at your accounting practices?

An IRS mandate: Educate about and deter tax fraud

Within the IRS, the Criminal Investigation (IRS:CI) unit takes a hard look at tax fraud, tax-associated money laundering, and illegal proceeds earned by legitimate companies through a variety of fraudulent methods. Some of the crimes pursued by IRS:CI include:

• Employment and payroll tax fraud: Payroll tax issues are common. Underreporting workforce numbers, collecting payroll taxes (federal unemployment, social security, and withholding taxes) and failing to pay them over to the IRS, or paying employees in cash under the table are just a few of the schemes pursued by the IRS. 
• Refund fraud: Most people know that filing a false income tax return could turn into tax litigation. Individuals and tax preparers engage in refund fraud and sometimes identity theft in order to obtain an unearned tax refund. This is also the realm where fake deductions, exemptions, and business expenses come into play.
• Abusive tax schemes: U.S. taxpayers who avoid filing regulatory reports like FBAR and FATCA could find themselves facing an IRS criminal tax investigation. With the proliferation of secrecy jurisdictions, individuals with significant wealth may seek the greater privacy available through offshore tax havens. There is often a fine line between an abusive tax scheme and a tax option used by an unwitting taxpayer trying to make legitimate use of offshore tax resources.

Committing tax fraud or tax evasion could provoke the interest of the IRS. But remember, the IRS is both underfunded and short-staffed these days. An important aspect of any tax crime is intent. It takes less time and money to work out a civil arrangement with a delinquent taxpayer than it does to try and convict that same taxpayer of a criminal offense. 

Examples of employment tax scams

Employment taxes can be tempting to those looking for a bigger payday. The IRS has identified a couple of common employment scams, including these:

• Pyramiding: This well-known scheme is the one we talk the most about. An employer withholds employment taxes but fails to pay them over to the IRS. While this happens in the context of established, well-regarded businesses from time to time, it is also the domain of fly-by-night contractors who set up businesses like employment agencies. After doing business for a period of time, operators bank employment taxes and then quickly wind down the business by declaring bankruptcy before leaving town to set up shop in another town.
• Leasing employees: The use of third-party vendors to lease, or lease back, employees can lead to employment tax problems in a couple of ways. If you arrange with a third-party provider to hire and handle your HR needs, it saves you the in-house hassle because the provider is handling administrative tasks—including collection and payover of employment taxes. Sometimes these providers skip town with the money or develop offshore tax routes to defer taxes.
• False tax returns: Filing a fraudulent payroll tax return is an easy way to underreport wages earned. Failing to file at all is also a basic form of employment tax fraud.
• Misclassification of Employees: Businesses might misclassify employees as independent contractors to evade the obligation to pay employment taxes.
• S-Corp Officer Compensation Handled Like a Corporate Distribution: This mislabeling of compensation facilitates the avoidance of employment tax liability.
• Paying in Cash: Employers often arrange to pay employees in cash to evade the responsibility for employment taxes. 

These are not new or novel mechanisms of employment tax fraud. Oftentimes, a business owner can become so enmeshed in the criminal enterprise, that they may convince themselves they will not get caught, or that what they are doing is not really a tax crime. But when the IRS comes calling, the situation quickly turns serious. The IRS rigorously pursues criminal sanctions against persons suspected of employment tax fraud. 

Tax Evasion—a Growing Crisis

According to a 2019 Brookings Institute report based on IRS statistics, tax evasion is responsible for one out of every six federal tax dollars owed but not paid. This has a huge impact on the U.S. economy. Every year, unpaid taxes amount to about 75% of the federal budget deficit.

The incidence of misreporting and evasion is particularly significant for sole proprietorships, farms, and high-income households. Illegal tax evasion and legal tax avoidance call into question the fairness of the federal tax system because lower-income households seem to pay more than their fair share of taxes.

Tax evasion is always illegal

Whether it is deliberate or inadvertent, tax evasion is illegal. Unreported income, reporting expenses you did not incur, or failure to pay taxes owed are common forms of tax evasion. Employment tax evasion (such as paying someone “under the table”) is also a common type of tax evasion. Mistakes on a tax return are an example of inadvertent tax evasion.

According to the Brookings Institute, tax evasion rates differ depending on the type of taxes and the manner of reporting:

• Payroll taxes and self-employment taxes account for 19% of tax evasion, but 39% of taxes paid.
• Corporate taxes account for 9% of evaded taxes, but only 9% of taxes paid.
• Individual income taxes account for 72% of tax evasion, but only 44% of taxes paid.

Legal tax avoidance strategies

While tax evasion can bring criminal penalties, including jail and substantial fines, tax avoidance is legal. Tax avoidance includes taking advantage of a property tax deduction and other deductions on a federal income tax filing as a way to limit or avoid taxes. Other legitimate forms of tax avoidance include setting up tax-deferred plans (IRSs, SEP-IRA, or 401k) and tax credits. Since the U.S. tax code is so complex, it's best to seek the advice of an experienced tax attorney before developing a tax avoidance strategy.

Do You Know if You Filed a False Tax Return?

Most of us would not intentionally commit tax fraud. Being convicted of filing fraudulent tax returns can put a crimp in your professional life, not to mention the possibility of going to prison. Yet, some people commit tax crimes without even knowing it.

When U.S. tax returns are filed, you sign on the bottom line that the information contained therein is accurate to the best of your knowledge. You attest that the return is an accurate reflection of your financial affairs as far as they are reported in the return.

If you have an accountant or tax preparer create your tax return, FBAR, or other report—you remain legally responsible for the accuracy of the information you provide to the IRS. Errors made on the return that lead to fines are paid by the taxpayer.

Be careful when choosing who prepares the tax returns that you sign. The IRS provides a directory tool for locating a preparer in your area with credentials recognized by the IRS. Here are a couple of tips for choosing and using a tax preparer:

• Never sign your return while it is blank as a convenience.
• Steer clear of tax preparers whose fee is related to the amount of refund you receive.
• Avoid tax preparers who guarantee you a bigger return than you might receive from another tax service.
• Check the history and credentials of your accountant, tax lawyer, or tax preparer. Are they a sole practitioner—if so, are they established in the community? Working with a longtime accountant or tax attorney ensures there is someone around to answer your questions if the IRS comes knocking several years from now.
• Be sure to obtain a copy of your return after it is filed.

The best way to protect yourself from filing a false income tax return is to verify the information going into your return and choose reputable professionals with verifiable credentials to prepare it. This does not mean you will never be audited—but it improves your chances of sailing through any questions that may eventually come your way.

Exactly How Serious is Failure to File Your Tax Return?

How troublesome is it if you fail to file your annual tax return, or your quarterly business taxes? This is not a trick question. The answer is, “it depends.”

If you do not owe any taxes, there is no penalty or fine for not filing a tax return. If you do not file though, you are also not eligible for any refund you may be due. The Internal Revenue Service refers to those who do not file tax returns (whether they owe or not) as “nonfilers.”

In the spring of 2020, nonfilers experienced the disadvantage of receiving economic stimulus payments later because they were not registered with the IRS.

While late refunds and other payments to nonfilers who have no tax obligation are unfortunate, they do not contribute to the tax gap. The tax gap is that gulf between how much tax should have been paid in any tax year, and how much was actually collected.

The U.S. relies heavily on voluntary compliance of taxpayers to file and pay their taxes. As employees, employment taxes that fund government programs are automatically withheld from your paycheck. Business owners are expected to calculate and file their taxes on time. Still, in 2019 the tax gap was $39 billion, so clearly there is a problem.

When identified, the IRS is not charitable with nonfilers who have a tax obligation that accrues due to a failure to file a return. The same thing holds for actual taxes owed on a fraudulent tax return. In the case of a false tax return, a taxpayer can quickly find themselves flirting with an allegation of tax crime.

Failing to file a tax return can quickly grow the amount of a tax liability. Taxpayers may earn a penalty for filing their return late. Even with an extension, there is a penalty for late payment of taxes owed. Combine any of the above with a false tax return and the amount of money owed goes up. Taxpayers trying to avoid paying by not filing a return can be charged with a misdemeanor or a felony. For those who simply quit paying their taxes over a number of years, an IRS criminal tax investigation can lead to federal prosecution.

The outcome of failing to file a tax return depends on a number of factors, including the skill of the criminal tax attorney retained to handle the matter. If you know you are in arrears, or are contacted by the IRS, speak with skilled legal counsel before responding to the IRS. The intervention of a good tax lawyer at any point in a tax matter can mitigate damages and lead to a better resolution than a criminal tax investigation allowed to run its course.

How the IRS Builds a Case for a Failure to Pay Payroll Taxes

Failing to pay payroll taxes is serious. The Internal Revenue Service does not take these matters lightly. In some cases, penalties for such violations can result in personal liability for those who are deemed responsible for paying these taxes. If the allegations are successful, the IRS can hold the person accused of failing to pay these taxes accountable for 100 percent of the missed payment.

Essentially, there are two main factors that the agency must establish to build a successful claim. The first is that the accused is responsible, and the second is that the failure was willful.

The definition of a “responsible party” for these purposes is fairly broad. It does not just include those who are directly responsible for making payroll tax payments but extends to include anyone who “has a duty to perform and the power to direct the collecting, accounting, and payment of trust fund taxes.”

Liability for these taxes also requires a finding that the failure to pay was willful or reckless. It is important to note that this requirement is also interpreted broadly. The failure does not need to be intentional to meet this requirement. The fact that a qualifying individual is aware of the failure is often enough.

Seems harsh? It certainly can be. The IRS’s broad definition of who is “responsible” for payroll taxes can result in serious allegations—even against those unaware of any failure to make payments.

Consider a case where both the president and CEO of a company were accused of failing to remit payroll taxes. Because they had authority over hiring, firing, and the company’s bank accounts, the IRS held them personally liable. On paper, this seemed to meet the criteria for responsibility. In practice, however, the company had designated a controller to handle payroll tax duties and engaged an outside accounting firm to conduct audits and file income tax returns.

As the business ran into financial trouble, the accounting firm initially gave the company a clean audit. But later, it was revealed that the controller had overstated receivables and failed to make payroll tax payments, which ultimately led to bankruptcy.

The IRS issued trust fund penalties against both the president and the CEO. A lower court sided with the IRS. But on appeal, the ruling was reversed—the appellate court found that the two executives had not willfully or recklessly failed to pay the taxes, in part because they had “no actual knowledge” of the controller’s failure.

What can I do to protect against tax liability?

Any allegation of wrongdoing from the IRS, including examples like the one noted above, should be taken seriously. Penalties for violations are often harsh. In addition to steep financial penalties, criminal penalties can also apply. As a result, anyone accused of a tax violation is wise to seek legal counsel.

Employee Misclassification: A Costly Mistake 

Business owners who unwittingly or deliberately misclassify employees can end up in an employment tax dispute with the Internal Revenue Service. Avoid the inevitable confrontation by knowing the differences between an employee and a legitimate contractor.

What is the problem?

Employers have an obligation to withhold and report payroll taxes, pay workers’ comp, and pay the employers' share of federal and unemployment taxes. There is generally no such obligation with an independent contractor. To avoid the outlay, some business owners misclassify their workers as independent contractors. Sometimes, the line between a worker and a contractor is so thin that it must be determined by a court—but for the most part, some bright lines offer guidance as to when an employee is just an employee and not a contractor.

To determine whether a worker is a contractor or an employee, the IRS looks at different factors like how work is assigned and performed, and how the working relationship is defined. Consider these points:

• Working relationship: If a worker is eligible for benefits such as health insurance, paid leave, and other perks, it signifies a type of relationship that does not exist with an independent contractor. Contractors are responsible for their own benefits, and their relationship with a business may be carefully (or not) defined by contract.
• Character of work: The “right to direct or control work” is a strong indicator of an employer/employee relationship. If a worker is classified as an independent contractor but is trained, supervised, and instructed by an employer—the worker may be misclassified, even if they do not receive employee benefits. Independent contractors are generally expected to obtain their own training, confer with a business owner on the work required, and then undertake that work in a self-directed way.
• Economics: Independent contractors must manage their own business and may have an investment in their company. Unless written into a contract, independent contractors are generally not reimbursed for business expenses. Contractors also negotiate with business owners for their fees and carry responsibility for the profit or loss of their own businesses. Employees are generally reimbursed for business expenses, accept an agreed-upon salary or wage offered by the employer, and, in the most specific sense, do not control the profit and loss of the company of their employer.

While many workers are afraid to speak up about misclassification, some inequities are coming to light—especially as stimulus programs and federal benefits become more widely available only to properly classified employees.

Knowing the difference between a contractor and an employee can save you penalties and additional tax liability for misclassified workers. If you have questions about employee classification or are involved in an employment tax disagreement with the IRS—talk to an experienced tax attorney for guidance.

Is Fraud Baked Into Your Employee Benefits?

Most companies offer basic benefits to their employees. Whether it's health insurance or wellness and retirement programs, business owners have a choice of what they want to provide and how much they want to pay for the perk.

Business owners also have a responsibility to abide by regulations, classify their employees correctly, and withhold and turn over payroll taxes, among other things. Our law firm works with business owners who find themselves on the wrong side of employment tax crime. We aim to defer charges or develop strategies to obtain the best outcomes. However, the IRS also works to identify tax fraud that is cooked into defined benefit or retirement plans.

In working to deter abusive tax shelters and tax evasion, the IRS lists transactions that it considers close to what it considers tax avoidance schemes. Some of these transactions include:

• Policies associated with retirement plans that increase deductible contributions even as they reduce taxable amounts due when the plan reaches distribution.
• Arrangements around life insurance policies that depress the cash surrender value of the policy as the policy is transferred to the employee. Following the transfer, the value of the policy increases.
• The IRS may question life insurance contracts where the death benefit exceeds the actual participant's death benefit defined under the plan.

For compliance, business owners should also be aware of double-dipping related to certain vendor programs offered to employees—like Wellness or Health Awareness plans. You may be marketed a Wellness program that utilizes pre-tax wage deductions and later returns those deductions upon participation in a health maintenance or prevention program. The IRS draws a line on some of these programs. Be wary of programs that are not employer-funded or where the worker receives tax-free payments throughout the year that are not related to an actual medical expense. 

There are also other types of fringe benefits, such as freebies offered by an employer that cost them nothing to offer, like this week’s season ticket, or one-time benefits of so little value they need not be reported as income—unless the IRS thinks they should. Bottom line—if you are offering creative tax benefits in your employee benefits package—speak with a tax attorney to ensure you steer clear of the IRS.

Employment Leasing: How it Can Lead to Trouble

Outsourcing payroll functions can save business owners and operators time and money. Using vendor expertise lets employers focus on marketing their core strengths and customer fulfillment. For some companies, it is a good deal—and sometimes it isn’t.

A professional employer organization (PEO) is a company that handles personnel services for small- to mid-size companies. These businesses are called employee-leasing firms. With pricing based on the number of employees served, PEOs often provide services that include:

• Benefit sourcing and service: With multiple clients, PEOs can source and provide benefits that might otherwise be out of reach to a small business. Health, vision, dental, and workers’ compensation programs can become affordable to employers using a PEO. Coordination of 401(k) and other pension benefits are also sometimes available through PEOs, saving entrepreneurs and owners the hassle of shopping and qualifying for affordable benefits for their workers.
• Payroll and compliance services: Employee payroll, collection and pay over of employment taxes, coordination of vendor payments, and filing of regulatory records are an important service offered by PEOs.
• Human resources: PEOs may offer recruiting and employee screening services, as well as workplace safety and risk management, consulting.

Due diligence is critical when considering a PEO, but there is more. Employee-leasing companies often come under extra scrutiny in any business community because the business model is often associated with tax fraud. Operating individually or as a network of affiliated companies, PEOs may operate respectably for a period of time—or the long term—before it is discovered that employment taxes withheld from workers, and taxes and premiums paid by employers have not been paid in full to vendors or turned over to the Internal Revenue Service.

The IRS may uncover the scam while the PEO is still operating. Oftentimes the company, or group of companies, has quietly wound down with tax obligations still owing and criminal tax charges pending.

Unfortunately, business owners may discover they have a large payroll tax issue when the IRS seeks payment of past-due tax liabilities. A PEO could provide valuable services to your company. If considering an employee-leasing service, careful investigation of your vendor may keep you out of an IRS criminal investigation later.

Pyramiding—The In-Business Repeater

A pyramid is a stable, solid form. As a payroll tax scam though, it is pretty shaky.

“Pyramiding” is a business model involving companies doing business for a relatively short period of time that collects employment taxes for its workers but fails to turn funds over to the Internal Revenue Service. When time runs out for the business as a going concern, the business files for bankruptcy to see its financial liabilities discharged. The owner operators then pack up and move elsewhere in the region, or in the country. This kind of scam is not to be confused with a multi-level marketing or pyramid scheme, although it is common for either a pyramid scheme or pyramiding to result in criminal tax charges.

Another term for “pyramiding” is an in-business repeater, that is, people who stay in business, creating financial liabilities from which relief is sought in bankruptcy court, or which simply go unpaid. When the pattern is recognized, those involved may be charged with tax crimes—if they can be located.

A “repeater” is a discretionary term used by the IRS for someone with multiple tax liabilities. It is not often used for someone with tax problems who is trying to work their way out of a financial fix, but for those committing tax fraud in the form of wind-down and pop-up businesses.

Being an in-business repeater earns you special attention from the IRS. Once on your trail, the IRS usually stays there, waiting for your repeat business. The IRS usually closes in fairly quickly on repeaters with significant tax obligations, by seizing assets and commencement of other legal proceedings. As well, in-business repeaters are usually tagged with paying taxes they failed to pay previously, with substantial penalties.

Cash on Hand—Paying Under the Table Can Cost You

Payment in cash is easy and fast. Workers appreciate cash and it saves business owners money and hassle—in the short term. Paying cash under the table can also lead to prosecution for tax fraud.

How you structure your payroll is important, regardless of the size of your business. You may be a small business owner or the CEO of a large corporation with several revenue units. Large or small, payroll—and payroll tax—are regulated and require regular, accurate reporting.

There are a number of reasons that employers pay workers under the table, including:

• Workers may not have documentation that would allow them to work in the U.S.
• Paying employees in cash usually means that employment taxes are not taken out of the payroll, reported, and paid over to the Internal Revenue Service. Other times, workers have employment taxes taken out of their pay, but the money is not accounted for or rolled over to the IRS on behalf of the worker.
• The same goes for businesses that are required to provide Workers’ Compensation benefits for employees. Payments made to employees may be made in cash, with no report or paystub to show withholding on their behalf. Eventually, the inability to obtain Workers’ Comp benefits after injury or workers who are unable to show withholding taxes on their tax returns can trigger an IRS tax audit.
• Employers or owners of struggling businesses may pay in cash to reduce short-term expenses or use withheld payroll tax revenue to pay their own personal expenses.

Regardless of whether you pay by cash or check, there are compelling reasons for collecting, accounting and turning over appropriate payroll deductions to the IRS. While prosecution, fines, and loss of liberty can be abstract threats to a business owner trying to line their pockets or pay past-due bills, the Trust Fund Recovery Penalty (TFRP) is a focused, clear penalty awaiting those who fail their duty to pay over payroll taxes.

As we have discussed earlier, the TFRP is a tool used by the IRS to go after those responsible for collecting and paying over payroll taxes. The TFRP shreds the corporate veil and leaves the personal assets of a business owner vulnerable to seizure for past-due amounts owed on workers whose tax obligations were not lawfully paid over.

The scenes of a worker signing an “x” in the payroll book in return for weekly cash pay exists only in the movies. As a business owner or operation, understand your payroll responsibilities and your payroll tax obligations. Avoiding payroll taxes by paying in cash can be one of the most expensive decisions you ever make.

What If It's Simple: You Just Didn't Deposit Your Employment Taxes

Employers in the U.S. are required to collect employment taxes and pay them over to the IRS. Not only that but responsible parties are expected to do so in a timely and correct manner. Not surprisingly, if there is an error along the way in the amount, timing, or method of depositing payroll taxes, you will likely be charged a penalty.

As we have discussed before, the IRS takes payroll taxes seriously and puts a priority on tracking down payroll tax fraud. Tax evasion through failure to deposit payroll taxes is common. Business owners or employees too often collect and withhold employment taxes to feather their own bottom line with the funds—rather than pay over the taxes. In addition to robust prosecution of payroll tax offenders, the IRS also uses the Trust Fund Recovery Penalty (TRFP); to collect missing monies from the personal wealth and assets of those responsible for paying the employment taxes in the first place.

In addition to the TFRP, the IRS will enforce the Failure to Deposit (FTD) penalty. The penalty represents a percentage of the employment taxes that are not deposited in the right way, in the right amount, and on time. Whether the reason is embezzlement or ignorance of the correct means to pay over the employment taxes—the outcome is costly.

Basically, the IRS expects you to deposit Medicare taxes, federal income taxes, and social security taxes monthly or semi-weekly. Deposits are to be accompanied by the appropriate, accurately completed forms. The deposit and the forms are transmitted electronically to the IRS.

The Failure to Deposit Penalty

If your payroll taxes are incorrect or untimely, the IRS will send you a notice of the FTD penalty. The penalty is determined by the number of days the correct deposit is late, beginning with the original date the deposit is due.

For example, if your deposit is late by one to five calendar days, your FTD penalty will be two percent of the unpaid deposit. If it is more than 15 calendar days late, that will cost you ten percent of your unpaid deposit. In what will come as a surprise to absolutely no one, the IRS charges interest on the FTD penalty.

Penalties and interest add up. If you have an employment tax dispute with the IRS—connect with the IRS at the phone number provided on the notice that you receive. Ignoring the notice—and the accruing penalties—will only make it a more expensive mistake. When you need to understand your options, talk to an experienced tax attorney for guidance.

Evading Employment Taxes Has Its Consequences

The temptation is too great—a business owner siphons employment taxes to fund the business or his lifestyle. You may be falling behind on paying over withholding taxes right now, but are convinced no one will notice. But what if the IRS already knows?

Enforcement around employment taxes is a priority for the Internal Revenue Service. Employment taxes fund the government that keeps the country moving. FICA taxes withheld from employee paychecks help support important programs like Medicare and Social Security. Workers who do not contribute sufficiently to these social programs may find their access to needed government assistance cut off when needed. Business owners or operators who pilfer FICA paycheck proceeds rarely take these downstream consequences seriously.

According to IRS data, employment taxes represent approximately 70 percent of all revenue collected by the agency. Theft of employment taxes also represents a significant part of the U.S. Tax Gap, which is the difference between taxes actually paid and owed in the U.S.

Another aspect of employment tax fraud occurs when an owner assigns the responsibility to collect and turn over payroll taxes to a staff member. When the malfeasance is discovered, the employee will be fired and possibly criminally prosecuted. What most business owners fail to factor in, when they embezzle payroll taxes or have an employee who does, is that they will be responsible for a Trust Fund Recovery Penalty (TFRP). The penalty is assessed against the party responsible for paying over employment taxes. If an employee steals withheld taxes instead of paying them over—the employer will pay.

As a result, the IRS often pursues criminal tax investigations of operators at the center of an employment tax dispute. The IRS has a healthy conviction rate for the cases it takes to trial for employment tax violations—for example, California business owner, Larry Kudsk.

Mr. Kudsk owns two construction companies that provide general contracting and subcontracting services. For both companies, Mr. Kudsk was responsible for withholding and paying employment taxes over to the IRS. For approximately two years, Mr. Kudsk failed to turn over withholding to the IRS. Following an IRS criminal tax investigation, and together with the U.S. Attorney, and the Department of Justice, Mr. Kudsk was arrested and will serve one year in prison, followed by three years of supervised release. For his trouble, Mr. Kudsk owes the government $244,973.00.

There is nothing exceptional about the crimes of Mr. Kudsk or about employment tax crime itself. The IRS takes a hard line against those who pocket money they should be paying over and work hard to prosecute business owners who do. If this is you—speak with an experienced criminal tax attorney today.

What if the IRS Reaches Out to Your Business: Understanding Civil Tax Audits

When the Internal Revenue Service is interested in your business, the result could be a civil tax audit.

Even if you know you have nothing to worry about, you might be concerned about receiving a friendly letter from the IRS suggesting that you sit down for a talk while providing a few years of your tax documents for review. To be clear, COVID-19 has changed a lot of things. The likelihood of any in-person IRS tax audit, or any tax audit for that matter, is diminished. During the lull, it is a good idea to brush up on why the IRS might be curious about your financials—and what they might do about it.

As we have discussed before, there are a couple of ways you could land on an IRS audit list, including:

• The IRS develops formulae against which taxpayer data is driven. Your return might fit a pattern, not fit a pattern, or simply be a “calculated” random choice.
• Your current or past returns may not fit an expected pattern, leading to your return being set out for review. You may have experienced a significant rise or drop in income, or again, software may identify an irregularity in your current return.
• If you are an investor or associated with a company or group of businesses that are under audit, your business and personal returns may be pulled in simply because you are associated with that cohort. Not exactly guilt by association, but not far from it.

If you are selected for an audit, the IRS will contact you via mail with directions about an audit. An audit can be performed by mail and that mode is likely to pick-up steam in the future. If you are contacted by telephone about an audit, do not reveal any information but politely ask for the name and telephone number of the caller. The IRS states they will not start a taxpayer audit by telephone.

The letter you receive should list out documents they would like to review, both hardcopy and electronic. Most of the time, audits are limited to the past three years of returns.

If you receive an audit letter from the IRS, read it carefully, and then contact an experienced tax attorney in your area. Legal counsel will help you respond on time with appropriate documents. Seasoned legal help can help keep the process smooth and uneventful, especially if you have a complex return or considerable wealth.

Have You Received an Upjohn Warning?

Internal company investigations are common. Most of these white-collar investigations are conducted and concluded. Others make headlines. If you receive an Upjohn warning as a result of an internal investigation, it is important to understand what you are looking at and where to get help.

Internal investigations are conducted for many reasons. The most common are those conducted out of concern for financial loss, payroll tax issues, embezzlement, tax fraud, money laundering, theft, conflicts of interest, or potential theft of intellectual property, among other topics.

It is not unusual for companies to retain outside vendors, like a law firm, to conduct an ostensibly fair internal investigation to examine potential wrongdoing. Such an investigation may ensue if the corporation is approached by a regulatory agency or the IRS. Some internal investigations have a big impact on those involved if potential corporate criminal liability is alleged. An investigation may ensue when the company needs to better understand its role in any violation of state or federal law.

During an investigation, you may receive an “Upjohn warning.” The term itself derives from a 1981 case before the Supreme Court titled Upjohn Co. et al v United States et al. One of the outcomes of the case impacted whether company lawyers could claim attorney-client privilege when speaking with non-management employees during an internal investigation. Mid-level or other employees often have information relevant to ongoing business but had heretofore not been protected in those conversations with company attorneys trying to get to the bottom of an issue.

As a result, today, an Upjohn warning is a procedural warning given to an employee that their conversations with company attorneys or investigators does not necessarily protect the employee. Employees have certain rights in serving the company, but the company holds the attorney-client privilege—not the employee.

It is important for the recipient of an Upjohn warning to understand that company counsel represents the company—not the employee. In that context, any conversation between a worker and the company lawyer should be considered by the worker to be confidential and resist disclosing information discussed to others. Importantly, the company can waive that privilege and disclose information provided to them by the employee to other parties. Another term for an Upjohn warning is a “corporate Miranda warning.”

If you are asked to participate in a company investigation and receive an Upjohn warning, you may be a person of interest in the investigation. If asked to participate in conversations about irregular accounting practices, employment tax disputes, or because of outside scrutiny from an IRS civil or criminal audit—speak with an experienced criminal defense tax attorney before engaging in an interview with investigators to better understand your options.

When Payroll Taxes Go Missing: Understanding the TFRP

Collection and payment of employment taxes to the U.S. Treasury funds programs like Social Security, Medicare, and federal unemployment. Failure to withhold and turn over payroll taxes can lead to a penalty against those responsible, which can be the business owner, partners, or corporate officers.

Whether through employment tax fraud or outright theft, if a business falls into arrears on its reporting and pay over of employment taxes, the IRS will eventually be in touch. The Trust Fund Recovery Penalty (TFRP) is a penalty charged against those with corporate responsibility for collecting payroll taxes and turning them over to the IRS. The TFRP is a severe measure intended to hold individuals accountable and recover taxes rightly due to the government.

If the IRS suspects you are in arrears on payroll taxes, you may be notified of an audit or IRS tax investigation. It is easy for business owners to fall behind on bills and start “borrowing” from payroll taxes to stay afloat. Or—just as often—business owners feel entitled to skim employment taxes to enhance their lifestyle. Either way, when the IRS asks where the money is—someone must pay up. This is where the TFRP comes in. The company and its owner(s) can be assessed the penalty while remaining an ongoing concern.

Consider these points about the TFRP:

• If an investigation points to embezzlement of employment taxes, the IRS will determine who was responsible for the collection of payroll taxes. If the accountant was unscrupulous and stole funds for personal use—the business owner will share in the payback and penalty. The responsibility cannot be discharged by assignment.
• To assess a TFRP, the IRS must find the failure to pay employment withholding was willful.  This could be the owner who is making use of employment taxes to pay their own bills—or it could be the employee who was supposed to be collecting the funds who had knowledge that payroll taxes were being skimmed to keep the lights on. There are three criteria of willfulness when it comes to the TFRP. They are a direct choice to embezzle money or pay other creditors instead of the U.S. government, knowledge that taxes are not being paid, and disregard for the responsibility to investigate and correct the situation.
• The TRFP is equal to the amount of taxes that should have been withheld and paid over, plus the same amount in the form of a monetary penalty. The IRS demonstrates a ready willingness to prosecute those who engage in employment tax fraud.

Options for business owners facing a TFRP are to challenge the charge, challenge the assessment of who is responsible, or arrange for and pay the fine. If you know your employment taxes are not being paid, speak with an experienced criminal tax attorney before the IRS speaks to you.

What You Need to Know about Eggshell Audits

The downward spiral of a business owner or company can be triggered by a simple letter from the IRS announcing a civil tax audit.

If you, or your company, are involved in tax fraud or have made a serious misrepresentation on your tax return, you are a candidate for an eggshell audit. An eggshell audit is a proceeding where the taxpayer and their attorney, or accountant, are aware of deficiencies and potential tax crimes that may be uncovered during a standard civil audit—and of which the IRS examiner is not yet knowledgeable.

The obvious danger of a civil audit is the identification of errors and omissions on your tax return at best. At worst, the auditor may uncover evidence of willful tax crime and the civil audit could turn into an IRS criminal tax investigation which has the potential to put you in prison. Because of taxpayer vulnerability, it is critical to work with an experienced criminal tax attorney before you respond to the IRS.

When seeking legal counsel, be sure to connect with a tax attorney who has specific experience representing clients charged with tax crimes. An accountant or tax attorney may be unable to offer you the protective guidance needed during an eggshell audit.

When you work with counsel—come clean. Provide documents and the truth about your activities to your attorney. Do not forget about a second set of accounting books or compelling evidence of tax crime that the IRS would love to see. Your attorney will carefully review your documents and discuss the matter with you. At this point, full disclosure to your attorney can establish privileged communication, gain legal protection, and help you understand your legal options.

As the process moves forward, your attorney will work with you prior to speaking with the IRS.  One of the great advantages the IRS has in conducting civil audits is a taxpayer who provides documents or discussion without the benefit of legal counsel. A civil audit can give the IRS an opportunity to hear from a taxpayer who is nervous and frightened. During conversation, a taxpayer without adequate counsel may reveal information damaging to their interests, and help lead the auditor to ask difficult questions that reveal even more.

During a civil audit, there are some tips that an examiner may have to uncover evidence of criminal activity:

• The audit is suspended
• The examiner asks about your intentions around certain transactions or issues a subpoena of bank or other records

• Document requests are excessive

During an eggshell audit, your best defense is experienced legal counsel. If potential tax fraud is identified, your attorney may be able to avoid the matter being referred for criminal prosecution. Beyond that, experienced counsel can help you avoid incriminating yourself and making a bad situation worse.

One Way to Avoid Tax Mismanagement: Early Interaction Initiative

One of the potential danger zones for business owners can be found in the collection and payment of payroll taxes. Far too often, owners of small businesses find that they fall behind on their bills and are tempted to use employment taxes to temporarily tide them over until things improve. There are a number of problems with this tactic, not the least of which is that the Internal Revenue Service can hit employers hard for the violation, assessing interest and penalties on top of the taxes owed.

Employment tax mismanagement can, in some cases, even result in criminal charges. Now the IRS says it is starting a new program—the Early Interaction Initiative—to identify employers in danger of falling behind on payroll taxes, and then help them to stay in compliance.

According to Accounting Today, the IRS says its guidance to employers will arrive in several forms, including letters and phone messages, and sometimes delivered in person by an agent. As many Cleveland business owners can attest, when an IRS officer knocks on your business door, it is time to have a discussion with a tax attorney.

While agents will invariably seem to be helpful, the reality is that a visit from a cash-strapped federal agency is not an occasion to chat. Take the agent's card, thank the agent for their time, but politely decline to discuss matters. Then give the card to a tax lawyer--someone who knows not only how to protect your rights, but also how to represent you in hearings, seizure procedures and other matters with the IRS.

How the IRS VCSP Might Help With Payroll Tax Issues

Employee classification is a hot button with the Internal Revenue Service. If you are aware of some classification misalignments in your company, the IRS Voluntary Classification Settlement Program (VCSP) could be the program you have been waiting for.

Employment tax disputes come up all the time. Problems arise when an employer is paying workers cash and not reporting them on their payroll. If there is an injury in the workplace, and there is no workers’ comp in place for the employee, things can get sticky. As well, so-called independent contractors who are essentially acting as employees become a problem at about the same time—when injuries happen, a payroll is audited, or a disgruntled employee finds out they do not have access to social net programs because their employer did not pay into Social Security on their behalf.

The IRS considers the willful misclassification of employees as tax fraud. An employer can avoid paying taxes and workers’ compensation on workers classified as independent contractors. Recent political battles in California resulted in gig workers maintaining their status as independent contractors. For some workers this was a victory, not so for others.

The IRS lays out some basic dividing lines for who is an employee and who is a contractor. The distinctions run along the lines of who controls or provides work assignments, how a worker is paid and reimbursed, and what kind of working relationship and benefits are in place.

For employers who are aware that some portion of their workforce is improperly classified, the IRS offers a voluntary settlement program that provides some benefits for correcting employee misclassifications. Some points of the program include:

• Application to the program is required and the IRS notes, “a taxpayer must have consistently treated the workers to be reclassified as independent contractors or other non-employees, including having filed all required Forms 1099 for the workers to be reclassified under the VCSP for the previous three years to participate.”
• An employer cannot be the subject of a current employment tax audit, or other investigation or litigation, concerning the classification of employees.
• By agreeing to classify the identified workers properly going forward, the employee will pay 10 percent of the tax liability that would otherwise have been due on compensation paid to the workers for the most recent tax year. The employer will not be liable for penalties or interest on the amount and the employer will not be subject to an employment tax audit for prior years on the workers identified for classification.

The VCSP offers an avenue toward compliance at a reduced cost. That said, if there are other questionable tax or employment practices in place at your company, it is a good idea to talk with a reputable tax attorney before applying to the program.

Start Off on the Right Foot: Payroll Tax Tips for Business Start-Ups

There seems to be a million details for entrepreneurs to attend to when starting up a new small business. One of those deserving attention before opening the doors of your commercial venture is payroll. Many a business that has come before yours has gotten themselves into trouble with the IRS over payroll tax issues. You certainly want to be sure to get a handle on any potential risks before opening day.

Before you hire any employees, it makes sense to set up a payroll system that will help you to take care of your obligations to your business, your workers, and the Internal Revenue Service. Failure to withhold payroll taxes or to remit withheld taxes can quickly turn the American dream of business ownership into a nightmare. An online small business publication urges entrepreneurs to take steps to “protect you from incurring expensive IRS penalties."

The first bit of advice from Small Business Trends is to get an EIN. The employment identification number (or employer tax ID) is an absolute must-have, enabling you to report taxes and more to the IRS. Simply contact the agency to obtain an EIN.

Also crucial: Figure out whether your workers will be employees or independent contractors. While it might make financial sense to have contractors doing needed tasks, you don't want to arrive at a spot later where the IRS determines that those contractors were actually employees misclassified.

Of course, once you have a payroll system up and running, begin filing required tax reports to the IRS and other authorities. Again, failure to collect the taxes and pass them along to the IRS can result in significant penalties, and in some cases, criminal charges. Taking care of these matters before problems develop can spare you the expense and headaches of employment tax problems requiring the assistance of a tax attorney.

Submit Your Business 1099s the Easy Way: The IRIS Portal

In a bid to boost customer service, the IRS recently launched a new portal to file required Form 1099 information.

The Information Returns Intake System (IRIS) was launched in January of this year and is aimed at creating a convenient, secure, option for businesses of all sizes that must file Form 1099. A form 1099 is generally required of businesses that made payments to others for a variety of goods and services. Similarly, those who received payments from others should file an appropriate return.

Former IRS Commissioner Doug O’Donnell said, "The IRS is excited to offer any business, especially small companies, a great new way to electronically file their 1099s for free. This simplifies filing for those issuing 1099s and helps recipients receive information timely. The launch of IRIS can help reduce the millions of paper Forms 1099 we project will be filed in 2023 and demonstrates our commitment to finding useful and innovative ways of reducing paperwork on the business community and others issuing 1099s. This is part of the larger effort underway to make improvements and transform operations at the IRS."

In providing the portal, the IRS hopes to provide benefits that include:

• IRIS will reduce the deluge of paper Form 1099s received by the agency each year, reducing processing time and, hopefully, backlog. As with any form of e-filing, the portal reduces the mailing, storage, and postage costs of continuing to use and submit paper records.
• The portal tracks and maintains 1099s issued from year to year, allowing users to log in and pick up where they left off. Additionally, the IRS plans to acknowledge receipt of filed 1099 Forms in approximately 48 hours, hopefully creating a business-friendly service that users can count on.
• IRIS can identify filing errors and deliver alerts if any information is missing. Filers can also make corrections to forms through the platform and file for automatic extensions.

In the IRIS system, the IRS also gains electronic access to required forms, boosting their compliance capabilities and making it easier to identify fraudulent income tax returns or mismatches between returns filed by taxpayers and the businesses that may have paid them during the year.

Enrollment to the platform is now available and the IRS is hoping early adopters will find the system convenient, easing reliance on the older FIRE system. The IRS bulk filing system will remain in use for at least the next two filing seasons. 

In recent years, the IRS has struggled to respond to customer inquiries and process returns and refunds in a timely way. The IRIS system may ease some of the burdens of paper forms if businesses find the portal will be beneficial to them.

Tips to Protect Yourself from Employment Tax Fraud

Diverting employment taxes is easy—but how do you protect your business and prevent an employment tax dispute with the Internal Revenue Service?

In a business of any size, employment tax collection and pay over to the IRS is an important responsibility. Depending on your business or corporate structure, responsibility for payment of employment taxes may land in the finance department, a sole accountant, or an outsourced vendor. Regardless of your business operation, you are responsible for the money owed to the IRS.

Some business owners are deep into deliverables, growth strategies, and staying afloat amid competition. Backroom operations like payroll are easy to delegate. In Ohio and elsewhere, the IRS expects employers to accurately report on income and taxes withheld. Turning over employment taxes to the IRS is part of that. Consider these tips for keeping your books and payments to the IRS above board:

1. Clarity: Classify and onboard employees properly. Misclassification of employees as contractors who are operating as employees is a quick tip-off that there are systemic business problems. Employee misclassification is a form of tax evasion. Whether you onboard your employees or use a service, be sure you can defend your classification.
2. Maintain process: Payroll accounting can be complicated. Employees without adequate training may not have the expertise and current understanding of regulations to handle the job. The individual, team, or vendor you put in place to manage your company finances and withholdings have direct impact on the viability of your company and your ability to respond without fear to an IRS audit. In short—be sure you can trust the people handling your money.
3. Checks and balances: Put checks and bounds in place to avoid payroll tax fraud. Appropriately restrict access to your accounting function and spread responsibility for different payroll functions between personnel. Choose your payroll accounting system software carefully and use alerts to track inconsistent or suspicious activity. Digital time-keeping should be part of the system to avoid payroll errors and collusion between employees and finance personnel in padding hours. Overall, ensure your process is being routinely reviewed and you are signing off on at least monthly reports that your operations are clean.

There is little to no defense for a business owner who claims they delegated their employment tax function to an employee or vendor. The IRS can apply a trust fund recovery penalty (TFRP) against the business owner and anyone in the organization who is responsible for paying withholdings but willfully fails to do so. With a TFRP, your personal income and assets are not protected if the IRS chooses to go after you.

Collection and remittance of payroll taxes is an important function for any business. Failure to account for employee withholdings has long-term consequences for the business owner, the business, and the employees whose social security benefits depend upon those payments.

$20 Million in Payroll Fraud—and 27 Ferraris to Show for It

Sometimes, business owners are tempted to dip into payroll tax withholdings. But a Florida man took payroll tax fraud to a whole new level.

Matthew Brown is a businessman with a taste for the high life. Brown owned and operated several businesses in the Palm Beach Gardens area, including a payroll servicing company called Elite Payroll. Many businesses outsource their payroll functions, including basic payroll, wage withholding, reporting, and paying over to the IRS. Elite Payroll was an outsourced vendor that managed payroll for businesses in the areas around Palm Beach, St. Lucie and Martin counties.

For Brown, it was go big or go home. According to the Department of Justice (DOJ), between 2014 and 2022, Brown purloined payroll taxes from the payroll of his business clients and the employees of his own businesses. To the tune of $20 million, Brown collected full employment taxes from his clients and then underreported the liability via fraudulent tax returns to the IRS.

It is not just the size of the take that makes this tax crime stand out, it is the length of time that Brown was able to carry out his scheme. Given that Elite Payroll serviced several businesses and was routinely falsifying reporting, it is odd that the IRS did not catch up to this fraudster sooner.

If not noticed by an eagle-eyed IRS special agent, one might think that the conspicuous consumption of Brown might have tipped off somebody. Brown put his ill-gotten gains right out there in the form of luxury cars, pricey real estate—residential and commercial—a yacht, an airplane, and yes, 27 Ferraris.

But it was all for naught. Brown was eventually nabbed in an IRS criminal investigation. His previously well-shod feet are cooling themselves in prison for a little over four years, after which two years of supervised release await. He will also pay a $200,000 fine and $22,401,585 in restitution for his crimes.

Tax schemes cannot go on forever. Payroll tax problems are routinely picked up by the IRS because they directly involve unsuspecting players. Shopping for your next Ferrari using the payroll taxes from your business? Buyer beware.

From Sleep Clinic to Prison: The Cost of Misusing Payroll Taxes

Tax fraud does not pay—especially fraud involving employment taxes.

Payroll tax problems are not uncommon in business. Understanding how to categorize employees, collect, report, and pay over wage taxes is required of those who own or operate a business. A larger problem occurs when employer payroll taxes are collected but not reported or paid to the Internal Revenue Service. The IRS Tax Division is charged with identifying non-compliant employers, who may find themselves involved in an IRS criminal investigation.

In the IRS Crosshairs

One individual who found himself in the IRS cross-hairs was David Neel, the owner and operator of a business in Virginia focused on sleep disorders. As previously discussed, employers and owners can quickly find themselves in difficulties with the IRS when they pay under the table, purloin payroll taxes, or file false payroll returns—among other issues. In some cases, theft of payroll taxes by an owner can be a desperate move to try and save a sinking bottom line. In other cases, it is a matter of proximity—business owners or their employees find the temptation of an account full of withholding too great to resist.

Neel is a member of the latter category, a sole owner who had no issue partaking of the payroll account. He sought an expensive lifestyle and found it in the monthly payroll withholding. Just some of his expenses, as detailed by the IRS, included:

• Education expenses for the daughter of a friend
• A new Ford F600 truck
• The rental of a 215-acre horse farm and house that came to roughly $220,000
• Life insurance expenses of $40,000
• About $30,000 for work on his personal (not rented) residence.

These goodies came at the expense of employees whose taxes were withheld but not paid to the IRS on their behalf from approximately 2015 through 2020, as well as employer taxes owed. During that time, Neel did not file a quarterly Federal Tax Return for his companies and paid over no wage withholding to the IRS—even though he was issuing annual W2s to his employees. Altogether, he took his employees and the IRS for about $460,543. 

Sentenced in late February 2025, Neel was sent to prison for the next two years. That is a lot of time to consider horse farms and payroll taxes.

$3.5M Payroll Fraud via Shell Companies and Fake Insurance

A recent Jacksonville, Florida tax crime offers a mashup of payroll tax fraud, shell company schemes, workers’ compensation fraud, and cooked books for good measure.

Along with a crew of conspirators, Honduran national Jose Molina-Herrera set up a business helping contractors and subcontractors avoid paying employer payroll taxes—for a fee. Molina-Herrera used his company, All National Remodeling LLC, as a shell entity to pay cash wages to workers and provide fraudulent workers’ comp insurance certificates to the contractors.

According to the Department of Justice, Molina-Herrera ran his scam from 2019 through 2020. For a business providing payroll services, the IRS expects business owners to maintain accurate records of employee rolls, wages, and payroll taxes withheld and paid over to the U.S. Treasury. For a fee of between six and eight percent of the payroll managed—Molina-Herrera did the opposite.

Blatant Employment Tax Fraud

All National Remodeling did not accurately record payroll taxes withheld or paid over, workers were paid under the table, and the contractors involved with the scheme used sketchy certificates of insurance to prove their workers were insured—although the contractors paid no insurance premiums. Cash was withdrawn from the shell company to pay workers, with no accounting or taxes paid.

The overall damages of the scam were impressive. Workers were paid more than $14M in cash wages without employee withholding, causing a loss of $3.5 million in taxes. Given the fraud, the insurance company with which All National Remodeling worked was taken for more than $2.2 million. Payroll tax crime does not affect just the IRS. Employees who are paid in cash, without payroll tax withholding, are not credited for purposes of social service programs like Social Security.

All National Remodeling was the subject of an IRS criminal tax investigation, which resulted in successful prosecution. Noted an IRS Special Agent, “using shell companies to pay workers under the table is not only illegal, it gives an unfair competitive advantage that businesses who do things the right way can’t match. We will continue to investigate these schemes to ensure compliance with the law and return competitive balance to the industry.”

For his part, Molina-Herrera pled guilty and was sentenced to more than two years in prison; one of his partners received more than four years behind bars. In addition, Molina-Herrera will pay approximately $3.5M to the IRS and forfeit another $867,005 in ill-gotten gains. Only Molina-Herrera knows if it was worth it.

Trust Fund Fallout: $750,000 Vanished from Paychecks

Report and payment of employment taxes are a fundamental responsibility of business owners who employ workers in the United States. An IRS:CI investigation recently exposed another business that collected employment taxes but failed to pay them over to the IRS.

According to the Department of Justice (DOJ), Eric Moesle of Pickerington, Ohio, worked as the office manager for Elemental Dental, a dental practice located in Pataskala, Ohio. From the internet, it appears Elemental Dental may have been a family business.

Evasion of employment taxes is an important focus for the IRS. Not only do employment taxes fund government initiatives, but they also establish a record of payment for workers to take part in social programs like Medicare and Social Security. Employment tax fraud steals from the government and the workers whose payroll taxes are not deposited.

Payroll taxes are generally reported on a quarterly basis along with the employer’s end-of-the-year annual filing of wages and compensation paid to each employee. The importance of paying employment taxes correctly and on time is emphasized by the Trust Fund Recovery penalty (TFRP), which can be assessed for non-compliance.

As we discussed earlier, the TFRP is a serious penalty that lands on the owner of the business, regardless of whether they assigned the task to an office manager, accountant, or third-party vendor. The amount of the TFRP is the amount of money not paid over for employees and the taxes due by the employer—plus the same amount as a penalty.

Mr. Moesle was the individual responsible for preparing tax returns, payroll, and bookkeeping for the dental practice. From 2014 through 2020, he correctly withheld payroll and income taxes, which employees could see on their paystubs and their annual W-2 forms. Yet, he failed to file quarterly tax returns and failed to pay over the worker’s payroll taxes and the business share of employment taxes.  

When questioned in an IRS criminal investigation, Mr. Moesle unwittingly claimed that he did not know the reports and monies had not been paid over. He also said the failure to pay over the employment taxes was unintentional. Mr. Moesle pled guilty in August of this year to not paying over $750,000 and faces up to five years in prison, plus what is bound to be a hefty fine and restitution.

It is unclear when Mr. Moesle sought legal help. Given the high profile of employment tax fraud with the IRS, it is usually only a matter of time before businesses are identified by the IRS for failing to report or pay over payroll taxes. As a legal group working with business owners and individuals facing IRS criminal investigations, here are a couple of tips—get good legal advice if you are engaged in a tax crime, and be sure to speak with your legal counsel before the IRS speaks with you. And when you do talk to the IRS? Do not lie—it will not help your case.

Two Sets of Books, Eight Million Missing: The Tony Luke's Case 

Many people get caught up in allegations of tax fraud. In 2020, the king of Philadelphia Cheesesteak and his son were indicted for filing false tax returns and other criminal tax charges. 

Take a hoagie, stuff it with thinly sliced steak and cheese, toast until the bun is crusty, the steak is steaming, and the cheese is melted, and top with anything you like. Tony Luke’s, a South Philly eatery owned by Anthony Lucidonio Sr. and son, Nicholas Lucidonio, is a famous local sandwich shop known for its cheesesteak. Unfortunately, it is not only the hoagies getting toasty these days, as the two owners were charged in late summer with cooking the books— keeping two sets of books that may have concealed as much as eight million dollars in receipts from the Internal Revenue Service (IRS). 

Altogether, 82-year-old Mr. Lucidonio Sr., and his son, 54-year-old Nicolas, face more than 20 counts of criminal tax fraud. 

We've previously discussed the problems that can rise when paying cash under the table, that is, cash paid without report to the IRS or payment of payroll taxes. The IRS alleges the duo kept two sets of books. In one set, they recorded, reported, and paid over employment taxes on a portion of their earnings from their business. The pair then paid employees a substantial amount more in cash—without withholding employment taxes or reporting the income. The accountant retained by the pair was directed to prepare false income tax returns and quarterly business returns. 

Of the indictment, the U.S. Attorney General working on the matter, William M. McSwain, stated, “Tony Luke’s is an iconic Philadelphia brand, but that is not what matters in the eyes of the law. These are serious allegations and it should go without saying that everyone has an obligation to follow the law. This alleged scheme victimized honest taxpayers in two ways: first, by hiding more than $8 million in revenue from the IRS and second, by avoiding payroll taxes.” 

The scheme apparently ran from 2006 to 2016, with a burp in 2015 when the pair were engaged in a courtroom franchising and recipe disagreement with Tony Luke Jr., also a son of Mr. Lucidonio. According to the indictment, Anthony and Nicolas were concerned legal troubles might shed light on their activities, so the 2015 returns were doctored to report more income—and also included fake income tax deductions to offset the increase in income reported.

If convicted, the father and son face years in prison, extensive fines, and probation. Although facing serious tax charges, they are presumed innocent until found otherwise. Whether you make a million dollars making sandwiches, steel, or in financial transactions, if you become embroiled in an IRS criminal tax investigation—speak with an experienced tax attorney for help mitigating the impact of charges that may be pending against you.