Saturday, March 1, 2014

“Largest Ever” Texas Payroll Tax Fraud Scheme


We prepare payroll for our clients. We do not handle money, mind you, but we do the calculations, observe the deposit schedules and prepare the tax returns. ADP and Paychex do the same thing, but in much larger volume.

Have you ever wondered who is responsible for penalties if these payroll taxes are not prepared correctly: you or me (that is, the provider)? Let’s ramp this up a notch: what if you remit monies trusting the provider to make the deposits … and they don’t? Think about this for a second. Would the IRS really expect you to make the deposit again? After all, you are out the monies remitted to the provider. And, if they did, would the IRS add insult to injury by applying penalties?

Chances are the answer is yes (to the first) and no (to the second).

Let’s review the buzzwords in this area and then let’s discuss a horror story.

Technically there are three types of payroll providers:

(1)   Payroll Service Providers (PSP)
a.     A PSP prepares the payroll tax returns but the client signs and files the paperwork. This is what we do. Under this arrangement, you remain the employer in the eyes of the IRS.
(2)   Reporting Agent (RA)
a.     RA’s prepare and file the paperwork. It is a slight difference, granted, and again you remain the employer in the eyes of the IRS.
(3)   Professional Employer Organization (PEO)
a.     PEO’s are more difficult to pin down.
                                                    i.     PEO’s perform the range of human resource functions: tax filings and administration, benefit design and ERISA, compliance with federal and state workplace regulations, disciplinary actions, unemployment, disability and workers compensation.
b.     It gets tricky on who is the “employer” in this instance. You are paying the PEO as a virtual outsourcing of your personnel and payroll departments. Odds are – for example – that the PEO is issuing W-2s in its name and identification number. Again, odds are that employee benefits – health and other – are also provided under their name.
                                                    i.     That sets up the question: who is the employer – you or the PEO?
c.      The tax law is not as clear as it could be.
                                                    i.     There is a way for the PEO to be the “employer”, but certain requirements must be met and paperwork has to be filed to notify the IRS.
d.     PEO’s commonly use an indemnity provision requiring them to reimburse you in the event of liability attributable to their failure to collect or remit taxes.
                                                    i.     An indemnity provision – by itself – is not enough to have the IRS consider the PEO to be the employer.
                                                  ii.     This means that – if all that happens is an indemnity provision - you remain the employer, and the IRS can act against you for penalties and undeposited taxes. 

What can go wrong?


I am looking at an FBI release dated February 21, 2014.  There is a court in San Antonio that is sending three individuals to jail for participating in what the FBI describes as “the largest real dollar loss fraud and tax related case ever prosecuted in the Western District of Texas.” At the core of this case were PEOs.

·       John Bean, owner of Synergy Personnel and an officer with several other San Antonio and Austin PEOs, was sentenced to six years in prison and order to repay more than $120 million in restitution.
·       Pat Mire, owner and manager of several San Antonio PEOs (including one with John Bean) was sentenced to three years in prison and order to repay $10 million.
·       Mike Solis, an executive at several San Antonio PEOs, was sentenced to two years in prison.
·       John Walker II owned and managed several San Antonio PEOs. He was sentenced to five years of probation and ordered to repay $450,000.

They had an unusual – but track-proven way - of dealing with the pesky payroll taxes they collected from clients and were supposed to remit to the government: they didn’t. Needless to say, they were extraordinarily profitable. They admitted that between 2002 and 2008 they stole more than $133 million from clients.

Good grief!

That is Nimitz-class payroll taxes, and someone is going to pony up. If you were a client of these PEOs, you would not want the IRS to come knocking, expecting you remit payroll taxes after you already paid these guys to do the same. You would be paying twice.   

The technical lexicon is that you want the PEO to be the “Section 3401” employer. The concept doesn’t apply to a PSP or RA, as their functions are limited. A PEO, on the other hand, performs so many of the employer functions that they practically “are” the employer. You want to be certain that the IRS agrees with that, though, by acknowledging the PEO as the “Section 3401” employer.

BTW, will the IRS go after the San Antonio employers? Truthfully, I cannot tell. I hope that the PEOs involved were the Section 3401 employers. Even if they weren’t, this case is so egregious that I would like to believe the IRS would make exceptional accommodation for the employers affected.

Update as of 3/10/14: Last Friday I had an IRS employment tax specialist in the office. Yes, she is auditing one of our clients (sigh). We spoke about the San Antonio PEO fraud and whether the IRS would accept 3401 status for the underlying employers.

She believes the IRS will act against the underlying employers and not even pause for any 3401 argument. Her observation: "it is a risk you take when you hire a PEO."

Be informed.




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