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.
