IRS Will Get Tougher on Unpaid Employment Taxes

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The Internal Revenue Service’s collections staff did not always take the right actions before giving up on collecting some types of unpaid employment taxes, according to a new government report that encourages the IRS to do more follow-up.

The report, by the Treasury Inspector General for Tax Administration, concerns in-business trust fund accounts. An employer holds in trust employment taxes, such as federal income, Social Security and Medicare taxes, for an employee until those taxes are paid to the U.S. Treasury. Employers are required to file employment tax returns and make matching contributions for the amounts withheld for Social Security and Medicare taxes.

The collection of taxes through employment tax returns is a significant source of revenue for the federal government. As of Sept. 30, 2009, the total IRS inventory of currently not collectible amounts included almost $20.7 billion of unpaid employment taxes from business taxpayers. Of that total, approximately $1.1 billion (roughly 5 percent) was from in-business taxpayers.

A 2008 report from the Government Accountability Office said, “While most businesses fulfill their fiduciary responsibility to the government to withhold taxes from their employees' salaries, make matching contributions, and remit these sums to the government, a significant number do not. As of Sept. 30, 2007, the IRS’s records showed that over 1.6 million businesses owed over $58 billion in unpaid payroll taxes, including interest and penalties.”

The large number of in-business taxpayers who are pyramiding trust fund tax liabilities is a major compliance problem for the IRS.

“While in-business taxpayers represent a relatively small portion of the business accounts declared currently not collectible, there is an increased risk that additional trust fund liabilities will accumulate, potentially creating a larger problem,” said TIGTA Inspector General J. Russell George in a statement.

The report found that the large number of in-business taxpayers that are accumulating trust fund tax liabilities is a major tax compliance problem for the IRS. Overall, TIGTA determined that the IRS’s Collection Field function needs to improve its collection actions for in-business trust fund accounts closed as currently not collectible. Because not all required collection actions were taken, taxpayers continued to accumulate additional trust fund taxes.

Generally, collection assignments for these liabilities go directly to the Collection Field function, where a revenue officer will seek to get the taxpayer to become compliant with current deposit and payment requirements, and request full payment of the taxes owed.

In those instances where the taxpayer cannot fully pay the back taxes, the revenue officer may explore other collection alternatives such as an installment agreement. However, in some instances, the in-business taxpayer may not have the ability to pay their back taxes, and enforcement actions cannot be taken because the business has no equity in assets. In these cases, the revenue officer can close the business taxpayer’s account as currently not collectible.

However, prior to doing so, the revenue officer must ensure the taxpayer is in compliance with current filing, deposit, and payment requirements, which may include the use of a letter to inform the taxpayer of the consequences of not depositing federal employment taxes. The officer may also file a federal tax lien notice, obtain a collection information statement, conduct a trust fund recovery penalty investigation, and make a recommendation of whether or not the penalty should be assessed.

Unlike a number of other currently not collectible dispositions, subsequent liabilities on these taxpayer accounts must be investigated by the Collection Field function to verify the taxpayer’s financial condition and to make a trust fund recovery penalty recommendation.

Also, because these cases will not be systemically re-activated if a taxpayer’s financial status improves, the revenue officer must request a mandatory follow-up review of the taxpayer’s account within 18 to 24 months after closing the account as currently not collectible.

In 20 (33 percent) out of the 61 cases reviewed by the TIGTA inspectors, revenue officers did not always secure, verify or analyze information to determine the taxpayers’ current financial condition or determine whether the taxpayers were current with their filing requirements. When all the required collection actions are not performed while a revenue officer is determining collectability of an in-business trust fund account, additional liabilities may accrue.

TIGTA estimates that improving controls to ensure required collection actions are pursued could potentially prevent approximately $84 million in liabilities from accruing per year, which is approximately $420 million over the next five years.

Mandatory follow-up reviews were not always requested and performed after in-business trust fund accounts were closed as currently not collectible, the report found. In 45 (49 percent) of the 92 cases reviewed, mandatory follow-up reviews were not performed.

These accounts were not available for further collection actions. TIGTA estimates that improving controls to ensure that the mandatory follow-up reviews are performed would make approximately $46 million of in-business trust fund liabilities available for collection each year, which is about $230 million over the next five years.

TIGTA made four recommendations to the IRS in its report. It recommended that the IRS provide training to Collection Field function managers and revenue officers emphasizing the importance of securing, verifying and analyzing financial information. The report also said the IRS should ensure that the Integrated Collection System and Internal Revenue Manual are updated to include verification of income and expense requirements. The IRS should also continue development and implementation of a systemic process within the Integrated Collection System to require the scheduling of mandatory follow-up reviews. In addition, the IRS needs to update its Centralized Case Processing function procedures to clarify mandatory follow-up review procedures and require periodic monitoring prior to mandatory follow-up review dates.

In response, IRS officials agreed with all four recommendations and outcome measures. The IRS has taken steps to implement several corrective actions and plans to take additional steps to address TIGTA’s concerns.

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Tax practice