IRS plans more safeguards against tax fraud by PEOs

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The Internal Revenue Service will be taking steps to deter the risk of employment tax fraud by professional employer organizations beyond the certification process it established in recent years, according to a new report.

The report, from the Treasury Inspector General for Tax Administration, pointed out that Congress enacted legislation in 2014 to reduce the risk of employment tax fraud by third-party payers, especially professional employer organizations. PEOs act as third parties for their client companies, paying wages to their clients’ employees and filing employment tax returns for them. The IRS has been certifying PEOs in recent years, requiring them to notify the IRS of the specific employers that use their services. However, employers who continue to use the services of PEOs that choose not to participate in the certification program remain at risk of employment tax fraud, the report noted.

In response to legislative provisions, the IRS has taken steps to put processes and procedures in place to issue a notice as confirmation of any business address change when required and to establish a voluntary program for PEOs to become federally certified. However, the majority of PEOs don’t participate in federal certification, so the IRS still can’t link employers who use the services of these organizations. The IRS has received applications for certification from 123 PEOs, as of March 31, 2017. However, in September 2015, the National Association of PEOs estimated there were between 780 and 980 PEOs representing 156,000 to 180,000 employers.

TIGTA said the IRS needs to develop processing time frames and procedures to periodically inform applicants about the status of their applications.

The 2014 legislation requires the IRS to issue a notice as confirmation of any address change of an employer making employment tax payments. To protect employers, payers and taxpayers from abusive third-party payroll providers, the IRS is required to send a notice to both the employer’s former and new address. Taxpayers aren’t required to respond to the notice, but the intention is to have taxpayers let the IRS know when they didn’t authorize a change of address.

TIGTA found, however, that some notices were being issued incorrectly and some notices weren’t issued at all. TIGTA identified 698,660 sets of notices unnecessarily issued to businesses whose address didn’t actually change. Using IRS cost data, TIGTA estimated the IRS unnecessarily spent nearly $3 million on the incorrect notices. TIGTA also identified 256,826 sets of notices that should have been issued to businesses whose addresses were changed but who didn’t receive a notice as required.

“Certification by the IRS provides certain federal employment tax protections for both Certified PEOs and the employers who use their services,” said TIGTA Inspector General J. Russell George in a statement. “However, unlike those PEOs that are federally certified, no such protection exists for those employers who continue to use the services of a PEO that chooses not to participate in the program.”

TIGTA recommended that the commissioner of the IRS’s Small Business/Self-Employed Division work with the Treasury Department to consider a legislative proposal requiring noncertified PEOs to register with the IRS and file Schedule R, Allocation Schedule for Aggregate Form 941 Filers, with their Form 941, Employer’s Quarterly Federal Tax Return, and establish timeliness standards for reviewing the applications. In addition, TIGTA made several recommendations to the commissioner of the IRS’s Wage and Investment Division to refine the programming criteria for the dual notice process.

The IRS agreed with all six of TIGTA’s recommendations and has planned or taken corrective actions.

However, the IRS pointed out that the certified PEO program remains voluntary. “As your report notes, the certification program remains voluntary,” wrote Mary Beth Murphy, commissioner of the IRS’s Small Business/Self-Employed Division, in response to the report. “The legislation only requires tracking of these relationships for the CPEOs.”

She also pointed out the IRS is getting better at reviewing the PEO applications. “The initial application review was complex and required a lengthier evaluation process than anticipated, due in part to the numerous steps required for application completion, which resulted in a longer than expected application processing time,” Murphy wrote. “After processing a sufficient number of applications, we will gain additional insight and knowledge to allow for application reviews to be handled more expeditiously.”

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Professional Employer Organizations Tax regulations Finance, investment and tax-related legislation Tax fraud Employment tax credits IRS TIGTA