Can Payroll Taxes Put You In Jail?

Can you go to jail for not remitting payroll taxes?

Let’s set this up:

• You have a temporary nursing staffing agency in Minnesota.
• You treat your nurses as independent contractors.
• You had a predecessor company which the IRS charged with willfully misclassifying workers and failing to remit payroll taxes.  You survived that occasion by settling with the IRS, but the settlement included language similar to the following:

 “... with respect to any other business similar to the ... entities that he might own, operate or control in the future, he would treat as employees for tax purposes all workers who performed functions or duties that were the same or similar as the function or duties performed by the nurses and nursing assistants who worked for the ... entities. In other words, defendant ... was obligated to withhold and pay over employment taxes for the nursing professionals who worked for any of his entities.”

• Minnesota has a law requiring nursing staffing agencies to certify that they are treating their nurses as employees and not as independent contractors. You have made this certification to Minnesota.

So, can you go to jail for not remitting the nurses’ payroll taxes?

A too-common problem is a cash-strapped business falling behind on depositing their payroll taxes. You can fall behind on many types of taxes and still be able to work something out. You fall behind with payroll taxes, however, and the IRS can be very harsh. The reason is that the IRS (and the states also) considers it stealing. You pay an employee $700 and withhold $200 for taxes. That $200 is not your money: it is the employee’s money that you now hold as agent for remittance to the IRS. The IRS reserves one of its most frightening penalties for this: it is called the trust fund recovery penalty. This penalty is 100% (you read that right), and it attaches to you as an individual. You cannot shed that penalty by leaving or bankrupting the business, because the penalty applies to you. It follows you like a bad haircut.

That penalty however is not what we have here. What we have here is Francis Leroy McLain (U.S. v McLain). The case was appealed to the Eight Circuit from the District Court of Minnesota.

The IRS looked at two entities owned by McLain, Kind Hearts and Kirpal Nurses, and came to the conclusion that the nurses were employees.

OBSERVATION: The IRS will almost always say that someone is an employee, whether they are or not. They want the payroll taxes, of course.

McLain owed about $340,000 in payroll taxes. He had been down this path before, and the IRS had not forgotten. They dusted off Section 7202, a very special tax gem for someone who pushes the sled too far:

Any person required ... to collect, account for, and pay over any tax imposes by this title who willfully fails to collect or truthfully account for and pay over such tax shall, in addition to the other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $10,000, or imprisoned not more than 5 years, or both, together with the cost of prosecution.”

McLain left the shores of the responsible person penalty far behind. He sailed into the deep waters of going to jail. He is now dealing with CID, the criminal side of the IRS.

NOTE: A word to the wise: you never want to deal with CID. These guys have badges. They have guns. And they will put you in jail. I know. I had a client who had gone to jail courtesy of CID, and I know a tax practitioner in northern Kentucky who will be going.

As a tax guy, I am hoping that McLain has some serious technical arguments to make in his defense. I am expecting a ferocious goal-line stand. Here comes his first play:

(1)   McLain referred to the two agencies, King Hearts and Kirpal Nurses, as “Kirpal.” He argued that Kirpal was the employer, and, as the employer, only Kirpal had a duty to account and pay over taxes on its employees.

COMMENT: McLain starts off by irritating me. There was a case on this issue before I even came out of school. The case is Slodov v United States. It was a Supreme Court case and included the following language:

“Sections 6672 and 7202 were designed to assure compliance by the employer with its obligation to withhold and pay the sums withheld, by subjecting the employer’s officials responsible for the employer’s decisions regarding withholding and payment to civil and criminal penalties ...”

            McLain was an officer. What part of this did he not get?

            SCORE: IRS (1) McLain (0)

(2)   McLain argues that he had a good faith belief that the nurses were not employees. The lawyers refer to this as “mens rea,” and he argued that his state of mind did not rise to “willful.” Without willfulness, McLain cannot come under Section 7202.

COMMENT: I like this argument. Unfortunately, he had a prior run-in with the IRS on this very same point, which greatly diluted the argument’s persuasiveness.

            SCORE: IRS (2) McLain (0)

(3)   McLain argues that the IRS has to pursue a civil penalty before it can pursue a criminal penalty, and the civil penalty requires a written notice. He received no written notice, so the IRS cannot proceed with criminal prosecution.

COMMENT: I noticed that the Court reminded McLain’s attorney that he “has an independent obligation, regardless of what his client may demand, to refrain from filing frivolous motions.”

            SCORE: IRS (3) McLain (0)

(4)   McLain moved to dismiss the charges because (1) he is a “natural human being” and the United States does not have authority over him.

COMMENT: McLain’s attorney blanched here, and McLain fired him. McLain represented himself from this point on.

A tax protest argument? Seriously?

SCORE: IRS (4) McLain (0)

McLain lost soundly.

This type of action by the IRS is rare. I can assure that – in almost all cases – the IRS does not want to put anyone in jail. They want your money, and being in jail impedes you getting the IRS any money. And all parties in the system – the IRS, the courts and judges, responsible practitioners – are tired of the tax protest siren song.

I am sympathetic to arguments that our tax system left the world of rational thought years ago, but that does not mean the income tax is illegal. It can be irrational, immoral, confiscatory, divisive and destimulative without being illegal.

McLain has taken what could have been a civil penalty – albeit a stiff one – and morphed it into a multi-year stay at Club Fed. There likely is a fairly impressive fine also. He did however enter the tax literature, primarily for being a blockhead.

Michael Bennett and an FBI Sting

Here is another former-NFL-player goes wrong tax story: Michael Bennett has been convicted of wire fraud and will serve 15 months in prison.

Who is Michael Bennett? He was drafted by the Minnesota Vikings in the first round of the 2001 draft. He was a Pro Bowl player. He was in the NFL until 2010, although he was a backup player for much of the time. Still, he earned millions of dollars from football. May we be so lucky.

How did he get arrested? It has to do with identity theft and tax refund fraud in North Miami. South Florida is a hotbed for tax refund fraud, and the FBI was operating a tax-refund and check-cashing storefront. It sounds like the business was quite lucrative, as the FBI was charging fees ranging from 35% to 45% of the face value of the checks. People would go the store and cash fraudulently-obtained checks, presenting false identification and sometimes forging the victim’s signature on the back of the check.

There was one ring of seven people which cashed approximately $500,000 of refund checks. The FBI caught the conversations and transactions on tape. Sadly, two former NFL players were in this crowd. Perhaps that is how we get to Michael Bennett.

In walks Bennett. He is not part of the tax-refund ring, but he does want to borrow money. He wants to borrow $200,000. I can understand. Surely many of us have been returning from lunch and decided to stop in at the cash-and-dash to borrow a couple of hundred grand. Bennett presents a bank statement showing that he had buckets of bucks at UBS, and the statement is accepted as “collateral” for a loan. On April 30, 2012 Bennett picked up a $150,000 check. He was supposed to pay back $280,000 after three months.

NOTE: Yes, I wrote the amounts correctly.

There was no money in his account, of course. Bennett admitted to altering his UBS statement to make it look like he had a lot of money there. He was arrested for wire fraud. He has until January 18, 2013 to begin serving his sentence.

My Take: Sad.

Thanks to Russ Fox for his post