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By Michael Trimarchi
The Internal Revenue Service should do more to protect employers that contract with third parties for withholding federal employment taxes and for making tax payments, the Treasury Inspector General for Tax Administration said in a report released April 1.
The report, which said 40 percent of small businesses rely on outside payroll processors, evaluated whether there were adequate controls to safeguard employers when third parties do not comply with payment and filing rules.
“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 J. Russell George, Treasury Inspector General for Tax Administration. “This causes significant problems for employers because the funds have been expended but the taxes are still due.”
The national taxpayer advocate expressed similar concerns March 2 in a recommendation that the IRS promote relief to employers for failures by third parties to make tax payments. (See PAG newsletter, March 11, 2015).
The most common third-party arrangements are payroll-service provider (PSP), reporting agent, professional employer organization (PEO) and Section 3504 agent. The agency found that of the four, only reporting agents and Section 3504 agents are required to submit an authorization form that discloses the relationship between them and an employer.
“Although the IRS does not have a way to link employers with a PSP, the risk of an employer not being aware of filing or payment improprieties on the part of the PSP is not as significant as it is for those employers that enter into a relationship with a PEO,” said the report, which was completed March 2.
For example, when employers use the services of a payroll-service provider, employment taxes are filed and paid under the employer's identification number. “In contrast, employers that use the service of a PEO are not associated with the tax returns and payments that a PEO makes on their behalf,” the report said. “The inability of the IRS to identify employers that use the services of a PEO is a concern we previously raised.”
The IRS, recognizing that there are possible risks associated with some third-party arrangements, meets regularly with industry groups to discuss the topic. Employers can enroll in the Electronic Federal Tax Payment System to monitor payments made on an employer’s behalf and to help safeguard the arrangement, the IRS said.
TIGTA said, however, that the ability to monitor payments via the electronic payment system is only possible for employers whose payments were submitted using their employer identification number through PSPs and reporting agents.
“The IRS is still unable to link employers with PEOs,” the report said. “Actions taken in response to prior TIGTA reviews have not adequately addressed the risks associated with employers that use the services of a PEO.”
A TIGTA review of 1,609 reporting agents who filed 28,635 Forms 941, Employer’s Quarterly Federal Tax Return for 2012, found that the address of the reporting agent was listed rather than the address of the employer.
In each case, the employer was not notified by the IRS that its address was replaced with that of the reporting agent, TIGTA said. “The replacement of the employer address with the reporting agent’s address commonly results from the filing of a Form 941 with the reporting agent’s address,” the report said. “When the tax return is processed, the address from the 941 tax return, i.e., reporting agent’s address, is automatically updated on the employer tax account if different from the existing address.”
As a result, the employer would no longer receive notices or other types of correspondence from the IRS alerting it that IRS records indicate it is in some way noncompliant, TIGTA said.
Congress, in recognizing the risk of an address change without notification of the employer, passed the Consolidated Appropriations Act of 2014 (Pub. L. 113-76) that includes a requirement for the IRS to notify employers of address changes.
The IRS is in the process of implementing these changes, TIGTA said. The IRS created a team that has drafted notice language, which is currently undergoing review and approval.
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 third-party processor with an employer,
•establish a program allowing employers to inform the IRS of PEOs they authorize to file and pay employment taxes,
•require processors 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.
Based on the recommendations, the IRS is developing a voluntary PEO certification program, which was authorized in December 2014. Although the program would link PEOs that certify to employers, it would have no effect on PEOs that do not seek certification. Without the certification, the IRS would be unable to identify noncompliance with payment and filing requirements, TIGTA said.
To contact the reporter on this story: Michael Trimarchi in Washington at firstname.lastname@example.org.
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