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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