General Session

May 21, 2009

Employment Tax Fraud Big Contributor to National Tax Gap, IRS Official Says

Uncollected employment taxes contribute to a significant portion of the annual gap between taxes owed and taxes ultimately collected nationwide, an Internal Revenue Service official told a general session of the American Payroll Association's 27th annual Congress May 21 in Long Beach, Calif.

Some $20 billion of the estimated total is accounted for by unreported income and approximately $5 billion has been reported on employment tax forms such as Form 941, Employer's Quarterly Federal Tax Return, but remains unpaid, Erick Martinez, director, field operations, Pacific Area, for the criminal investigations unit at IRS, told APA attendees.

About 95 percent of the federal government's revenue is collected by IRS, Martinez said, and 70 percent of that is accounted for by employment taxes.
 
Leads for Prosecution

The IRS Criminal Investigations unit gets its cases from several sources, including corporate payroll employees, Martinez told BNA in a post-address interview. “If they find the employer is doing something wrong, they have the conscience to come forward with the information,” he said.
Other leads come from a wayward company's competitors, the U.S. Department of Labor, and the Social Security Administration.

“If they're not making pension or disability payments, if they're not making Social Security contributions, that constitutes a red flag, and we are notified,” Martinez said.
 
Types of Employment Tax Fraud
 
There are four basic types of employment tax fraud, Martinez said. The first is when an employer pays employees "under the table" without withholding or remitting any taxes. Martinez cited a recent example of this in which Daniel McElroy and his wife Aimee King McElroy were sentenced to 108 months and 78 months in jail, respectively, and ordered to pay $9.1 million in restitution for running temporary employment agencies where wages were paid in cash to avoid employment taxes. In another case, Lucky Mata, owner of a South Florida concrete construction company, was sentenced to 10 years in prison for underpayment of payroll taxes.
 
A second type of employment tax fraud is called "pyramiding" and occurs when business owners pay employees, do not remit withheld taxes, then leave the first company and form another one with assets transferred from the first. The "straw companies" used to pay employees then file for bankruptcy.
 
A third type of employment tax fraud that has become increasingly common involves fraudulent professional employee leasing companies, Martinez said, which collect money from clients to pay taxes but never remit these amounts to the government on behalf of their clients. Principals of a payroll services company, Provident Management Group of Salt Lake City, were recently fined $2.2 million and jailed for collecting the payroll taxes of client companies and never passing the funds on to IRS, while concealing tax delinquency notices that IRS issued on customers' accounts. Three company officers were given prison sentences ranging from 30 to 70 months.
 
A fourth type of employment tax fraud occurs when tax protesters or unscrupulous accountants encourage or advise clients to file and pay income taxes, then apply for refunds on those amounts.

"This is a scam," Martinez said.
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Goals for 2009
 
IRS's goal for 2009 is to focus on high-impact employment tax cases, according to Martinez, including employee leasing cases and small business self-employed reporting fraud, through examinations buttressed by more exchanges of information between federal and state tax agencies.
 
Unscrupulous tax return preparers also will get a closer look, Martinez said. These can be licensed or unlicensed and are typically looking for a competitive advantage through defrauding either IRS or their own clients.
 
“You especially find the second type in earned income tax filings where the taxpayer is less sophisticated and more vulnerable to these practices,” said Martinez.