Business Protection from Payroll Provider Fraud

Many businesses rely on third parties to handle their payroll, including making withholding deposits with the IRS on behalf of the business. Way too often, the payroll provider will embezzle the funds and not pay them over to the IRS.

In this circumstance, the business is still on the hook for the unpaid employment taxes. To add insult to injury, if the IRS takes a hard line it will usually be successful in obtaining interest and penalties from the business. This is based on the view of the courts that a taxpayer's duty to file returns and pay taxes is nondelegable. For a recent example where the employer was held responsible for interest and penalties, see Kimdun, Inc. v. U.S., 118 AFTR 2d 2016-5508 (DC CA 2016).

So what can employers do to protect themselves? One thing that should be done is to check online with the IRS through the FTPS system on a regular basis to confirm that deposits are being made. While doing this may or may not help in a penalty dispute with the IRS, it will alert the business to problems before the tax and penalty liability builds up.

Here is an excerpt from the Internal Revenue Manual on this subject:

5.1.24.5.3  (08-15-2012)
Use of Electronic Federal Tax Payment System (EFTPS) for Payment Verification

An employer should ensure its PSPs are using EFTPS so the employer can confirm payments are being made on its behalf. An employer can register on the EFTPS system to get its own PIN and use this PIN to periodically verify payments. A "red flag" should arise the first time a payroll service provider misses or makes a late payment.

When an employer registers on EFTPS, it will have on-line access to its payment history for 16 months. In addition, EFTPS allows an employer to make any additional tax payments its third-party payer is not making on its behalf, such as estimated tax payments.