Better processes are needed to reduce the risks of employment tax fraud, according to a new government report.
The report, from the Treasury Inspector General for Tax Administration, found employers that arrange to have a third-party payer handle their federal employment tax withholding and tax payment responsibilities are potentially at risk of being defrauded.
Approximately 40 percent of small firms use a third-party payer for tasks ranging from paying employees to paying federal employment taxes, according to the report. There are four common types of third-party payer arrangements: payroll service provider (PSP), reporting agent, Section 3504 agent, and professional employer organization (PEO).
For its report, TIGTA evaluated whether controls are adequate to protect the taxpayer's and government's interests when third-party payroll providers are not compliant with payment and filing requirements.
“While third-party payer arrangements usually work as intended, there have been instances in which third-party payers receive funds from employers for payment of payroll taxes, but they have not remitted those taxes to the IRS,” said TIGTA Inspector General J. Russell George in a statement. “This causes significant problems for employers because the funds have been expended but the taxes are still due.”
TIGTA found that processes have not been established by the IRS to link employers with all third-party payers. Of the four most common types of third-party payer arrangements, only reporting agents and Section 3504 agents are required to submit an authorization form that discloses the relationship between an employer and a third-party payer. The IRS does not require a similar authorization for employers that use a PSP or a PEO. TIGTA raised concerns about the IRS’s inability to identify employers that use the services of a professional employer organization in earlier reports it issued in 2007 and again in 2011.
In addition, the IRS does not always accurately process authorization forms, the report observed. TIGTA’s review of 85 agent authorization forms processed in 2013 identified 11 forms with errors. Because of these errors, authorizations provided by employers to their reporting agents were incorrectly reflected in IRS systems.
Finally, the IRS has not established an effective process to ensure that indicators are accurately assigned to Section 3504 agent and employer tax accounts, according to a report. TIGTA's review of the tax accounts associated with Section 3504 Agents filing 78 Forms 2678, Employer/Payer Appointment of Agent, identified 13 that contained erroneous indicators. The errors incorrectly identified Section 3504 agents as employers and vice versa.
TIGTA recommended that the IRS partner with the Bureau of the Fiscal Service to develop a plan to use the Electronic Federal Tax Payment System to link a PSP with an employer; establish a program in which employers can inform the IRS of the PEOs they authorize to file and pay employment taxes; require those PEOs with a service agreement to attach a Schedule R (Form 941), Allocation Schedule for Aggregate Form 941 Filers, to employment tax returns; and, develop processes and procedures to ensure authorization information and Section 3504 agent indicators are accurate.
The IRS agreed with three of TIGTA’s five recommendations and partially agreed with two. The IRS said it is working on establishing the voluntary certification program for PEOs that was enacted into law in December 2014. While the voluntary certification program will link PEOs that certify to employers, it will have no effect on PEOs that do not certify. TIGTA pointed out that the IRS will continue to be unable to readily identify noncompliance with payment and filing requirements on the part of these non-certifying PEOs.
Karen Schiller, commissioner of the IRS’s Small Business/Self-Employed Division, noted in response to the report that the IRS has developed an Outreach and Communication Plan to remind employers that they remain responsible for ensuring tax compliance, including timely filing of returns and payment of taxes when using the services of a third-party payer.
“Also, on April 14, 2014, the IRS and the Department of Treasury issued final regulations clarifying that when a third party payer enters into a service agreement with an employer which includes the third party filing returns and paying taxes on behalf of the employer, then both the employer and the third party are liable for the employer’s employment tax obligations,” she wrote.
She also pointed out that on Dec. 19, 2014, Congress enacted a law that “changes the landscape” of the IRS’s authority with respect to PEOs, requiring the IRS to establish a voluntary certification program. A PEO can apply to the IRS for certification, and if it meets the requirements, it would be solely liable for the employment taxes on wages paid to employees performing services for any customer of the PEO.
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