Over the last few years, the Justice Department has worked with the IRS to more aggressively prosecute cases involving employment tax noncompliance and the failure to remit trust fund taxes to the U.S. Treasury.  Trust fund taxes are taxes withheld from the wages of employees such as federal income tax withholding and FICA tax withholding.  Owners, corporate officers, and employees who are responsible for remitting such taxes may also be found to be personally liable for the failure to pay over trust fund taxes and, as the following described cases indicate, they may face criminal prosecution for such failures. 

Businesses and responsible individuals alike should understand that civil and criminal liability for trust fund tax failures may arise at both the federal and state level and may relate to taxes other than employment taxes.  For example, backup withholding under section 3406 and withholding taxes under Chapter 3 and 4 of the Internal Revenue Code related to payments of U.S. source income paid to non-U.S. payees also constitute trust fund taxes for which the government may pursue responsible persons.  The cases summarized below reflect the latest postings on the Justice Department website related to employment tax enforcement.

North Carolina Mother and Daughter Enter Guilty Pleas for Employment Tax Fraud

A 57-year old woman and her 40-year old daughter who operated a temporary staffing business in Greensboro, North Carolina entered guilty pleas for failing to pay over employment taxes.  The Justice Department reports that the proprietors changed the name of the business twice even though the actual operations of the business did not change, and they did not remit withheld employment taxes to the federal government.  Their alleged failures continued even after the daughter plead guilty to state charges of embezzling employee state tax withholdings.  While the daughter was incarcerated by the state, her mother allegedly continued to withhold taxes from employees without paying the withheld taxes over to the U.S. Treasury.  The pair face a maximum sentence of five years in prison, supervised release, restitution, and financial penalties.

New York Plumbing Contractor Pleads Guilty to  Employment Tax Fraud

A plumbing contractor in New York entered a guilty plea for filing false employment tax returns that failed to report cash wages paid to workers and the employment taxes due.  The business owner is alleged to have used the proceeds from customer checks to pay workers in cash without properly reporting, causing a loss of more than $360,000 to the federal government.  The contractor faces a maximum sentence of five years in prison, supervised release, restitution, and financial penalties.

New Jersey Home Health Care Agency Operator Sentenced to Prison for Failing to Report and Pay Employment Taxes

U.S. District Court Judge Peter Sheridan sentenced a New Jersey business owner to serve a prison sentence of 12 months and one day for willfully failing to remit federal employment taxes.  The business owner did not remit a substantial amount of federal employment taxes, including trust fund taxes, nor did the owner file the required federal employment tax returns.  In addition to the prison sentence, the defendant was ordered to serve three years of supervised release and pay over $500,000 in restitution to the United States.

Conclusion

Although the cases above involve relatively small employers, large employers who engage in mergers and acquisitions with start-ups and distressed companies should be mindful of potential trust fund tax liabilities during the diligence process.  Although large employers typically have the resources to make good on their own withholding errors, potentially large liabilities can arise from withholding errors at smaller targets that can drastically change the deal proposition.  For example, backup withholding failures combined with associated information reporting penalties can quickly reach millions of dollars in potential exposure for each year of non-compliance.  For companies engaged in small- and mid-market M&A activity, overlooking compliance in this area during due diligence can result in a bad deal.