On August 19, 2020, the IRS urged employers to exercise caution in selecting their payroll service providers (“PSPs”) following ongoing concerns that some disreputable PSPs may fail to deposit employment taxes, leaving businesses vulnerable to unpaid payroll taxes as well as penalties.

Many employers outsource their payroll and related tax duties to third party payroll processors.  Under these arrangements, a third party often fulfills an employer’s employment tax return processing and employment tax remittance obligations.  Although the vast majority of PSPs dutifully fulfill their responsibilities, there have instances when certain PSPs violated their fiduciary duties to their clients.  (For example, see our earlier coverage of the MyPayrollHR scandal.)  In particular, some PSPs withdrew employment taxes from their clients’ bank accounts, failed to remit those amounts entrusted to them to the U.S. Treasury, and closed their doors abruptly, leaving their clients liable for the unpaid payroll taxes.  The Department of Justice maintains a webpage that reports on its employment tax enforcement efforts.  This DOJ webpage includes a link to posts regarding criminal enforcement action taken by the Department.

Like employers that handle their own payroll responsibilities, employers that outsource this important business function generally remain legally responsible for the employment taxes due.  These amounts include any federal income taxes withheld as well as both the employer and employee shares of Social Security and Medicare taxes.  This is true even if the employer provides the funds to the third party to make the required deposits or payments on the employer’s behalf.  Moreover, certain employer personnel (referred to as “responsible persons”) could be subject to personal liability for the employment taxes withheld from employees but not remitted to taxing authorities if the employer is ultimately unable to satisfy the obligation.

One third-party arrangement that can reduce this risk for the employer is to contract with a certified professional employer organization (CPEO).  Unlike other third parties, in most circumstances, the CPEO is generally solely liable for paying the customer’s employment taxes, filing returns and making deposits and payments for the taxes reported with regard to wages and other compensation it pays to its customer’s workers.  The start and end dates of an employer’s contracts with a CPEO must be reported to the IRS on Form 8973 (Certified Professional Employer Organization/Customer Reporting Agreement).  Form 8973 also notifies the IRS of the tax returns the CPEO will file to report wages or compensation paid to employees performing services for the customer.

Other third parties, such as PSPs and reporting agents (“RAs”) may also work well for some employers.  An RA is a PSP that has informed the IRS of its relationship with its client using Form 8655 (Reporting Agent Authorization), which is signed by the client.  An RA is required to deposit its client’s taxes via the Electronic Federal Tax Payment System (“EFTPS”) and is authorized to exchange certain information with the IRS on behalf of its client.  For an overview of how the roles and obligations of PSPs, RAs, and CPEOs differ, see the Third Party Arrangement Chart.

The IRS urges employers to take the following steps to protect themselves from unscrupulous third parties:

  • Enroll in EFTPS and make sure the PSP or RA uses EFTPS to make tax deposits. Available free from the Treasury Department, EFTPS gives employers safe and easy online access to their payment history when deposits are made under their Employer Identification Number, enabling them to monitor whether their PSP or RA is properly carrying out its tax deposit responsibilities.  It also gives employers the option to make any missed deposits themselves and allows them to pay other individual and business taxes electronically, either online or by phone.
  • Understand that the employer, not the RA or PSP, is ultimately liable for the timely filing of returns and payment of taxes. RAs are required to deposit clients’ taxes via EFTPS and, with limited exception, electronically file the tax returns.  They are also required to provide clients with a written statement reminding the employer that it, not the reporting agent, is ultimately responsible for the timely filing of returns and payment of taxes.  This statement must be provided upon entering into a contract with the employer and at least quarterly after that.  See Reporting Agents File for more information.  If the PSP fails to make the federal tax payments, the employer is liable for any taxes, penalties, and interest due.  The IRS may also file liens and issues levies against the employer.
  • Refrain from substituting the third party’s address for the employer’s address. Though employers are allowed to make or agree to such a change, the IRS recommends that an employer continue to use its own address as the address on record with the tax agency.  Doing so ensures that the employer will continue to receive bills, notices, and other account-related correspondence from the IRS.  It also gives employers a way to monitor the third party and easily spot any improper diversion of funds.
  • Report PSP fraud.  If an employer suspects its PSP of improper or fraudulent activities involving the deposit of federal taxes or the filing of returns, the employer can file a complaint using Form 14157 Complaint: Tax Return Preparer.  Once received, PSP-identified complaints will receive expedited handling and investigation.