Although the facts are still unfolding, recent developments surrounding the collapse of payroll firm MyPayrollHR serve as a reminder to employers to regularly verify the actions of payroll service providers.  This should be a routine practice, regardless of the provider’s reputation and the longevity of the relationship.  In particular, employers should open their own EFTPS accounts with the IRS and verify that all deposits are being made on-time to their payroll tax accounts with tax authorities.  If deposits are not timely reflected on accounts, it is incumbent on employers to promptly determine the source of the problem.  The IRS does not regulate payroll service companies, but the Department of Justice has prosecuted a number of people for embezzlement of payroll taxes over the years.

Nearly 8,000 employees at 400 small businesses across the country were affected by the collapse of MyPayrollHR.  The company, which shuttered earlier this month, is being investigated by the Federal Bureau of Investigation.  It is unclear exactly what happened, but reports indicate that money that should have been sent from MyPayrollHR to a third-party direct-deposit processor was instead diverted to another account under MyPayrollHR’s control.  The direct-deposit processor, which had originally deposited worker’s paychecks, reversed the transactions when it discovered it had not received the funds from MyPayrollHR.  Subsequently, due to a processing error, the transactions were reversed a second time.  Questions have been raised regarding whether the reversal of the payroll deposits was appropriate under rules governing ACH transactions.

Although employees did not receive their net pay, some reports indicate that associated payroll taxes, including federal and state income tax withholding and FICA taxes, may also have been diverted.  If that proves to be true, the employers may be on the hook for those missing taxes.  Employees, however, are protected from the consequences of diverted payroll taxes as they are entitled to a credit against their personal income tax regardless of whether the Treasury Department received the withheld taxes under section 31 of the Code.

In addition to the missing taxes, employers may also be liable for potential failure-to-deposit penalties under section 6656 and related interest.  Courts have historically considered the typical authorities that arise in reasonable cause determinations and concluded that an employer’s reliance on a payroll company, an agent, does not establish reasonable cause.  To avoid such a result, employers should proactively take steps to ensure payroll deposits are being timely made by their payroll service provider.  If the employer discovers late or missing deposits, steps should be taken to deposit promptly any late taxes in an effort to avoid or mitigate any potential penalties.

The key takeaway is that employers will not automatically be absolved of the tax obligations on wages paid to their employees because of the illegal acts committed by third-party agents.  With the tools available from the IRS through EFTPS, employers should independently verify that their payroll service providers are timely performing the tasks they agreed to perform.

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Photo of S. Michael Chittenden S. Michael Chittenden

Michael Chittenden practices in the areas of tax and employee benefits with a focus on the Foreign Account Tax Compliance Act (FATCA), information reporting (e.g., Forms 1095, 1096, 1098, 1099, W-2, 1042, and 1042-S) and withholding, payroll taxes, and fringe benefits. Mr. Chittenden…

Michael Chittenden practices in the areas of tax and employee benefits with a focus on the Foreign Account Tax Compliance Act (FATCA), information reporting (e.g., Forms 1095, 1096, 1098, 1099, W-2, 1042, and 1042-S) and withholding, payroll taxes, and fringe benefits. Mr. Chittenden advises companies on their obligations under FATCA and assists in the development of comprehensive FATCA and Chapter 3 (nonresident alien reporting and withholding) compliance programs.

Mr. Chittenden advises large employers on their employment tax obligations, including the special FICA and FUTA rules for nonqualified deferred compensation, the successor employer rules, the voluntary correction of employment tax mistakes, and the abatement of late deposit and information reporting penalties. In addition, he has also advised large insurance companies and employers on the Affordable Care Act reporting requirements in Sections 6055 and 6056, and advised clients on the application of section 6050W (Form 1099-K reporting), including its application to third-party payment networks.

Mr. Chittenden counsels clients on mobile workforce issues including state income tax withholding for mobile employees and expatriate and inpatriate taxation and reporting.

Mr. Chittenden is a frequent commentator on information withholding, payroll taxes, and fringe benefits and regularly gives presentations on the compliance burdens for companies.

Photo of Marianna G. Dyson Marianna G. Dyson

Marianna Dyson practices in the areas of payroll tax, fringe benefits, and information reporting, with a specific focus on perquisites provided to employees and directors, worker classification, tip reporting, cross-border compensation, backup withholding, information reporting, and penalty abatement.

Ms. Dyson advises large employers…

Marianna Dyson practices in the areas of payroll tax, fringe benefits, and information reporting, with a specific focus on perquisites provided to employees and directors, worker classification, tip reporting, cross-border compensation, backup withholding, information reporting, and penalty abatement.

Ms. Dyson advises large employers on the application of employment taxes, the special FICA tax timing rules for nonqualified deferred compensation, the voluntary correction of employment tax errors, and the abatement of late deposit and information reporting penalties for reasonable cause. On behalf of the restaurant industry, her practice provides extensive experience with tip reporting, service charges, tip agreements, and Section 45B tax credits.

She is a frequent speaker at Tax Executives Institute (TEI), the Southern Federal Tax Institute, and the National Restaurant Association.