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.
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Photo of Michael M. Lloyd Michael M. Lloyd

Michael Lloyd practices in the areas of tax and employee benefits with a focus on information reporting and withholding on cross-border payments (e.g., Forms 1042 and 1042-S) and Foreign Account Tax Compliance Act (FATCA), backup withholding, employment taxation, the treatment of fringe benefits…

Michael Lloyd practices in the areas of tax and employee benefits with a focus on information reporting and withholding on cross-border payments (e.g., Forms 1042 and 1042-S) and Foreign Account Tax Compliance Act (FATCA), backup withholding, employment taxation, the treatment of fringe benefits, cross-border compensation, domestic information reporting (e.g., Forms W-2, 1099, 1095 series returns), penalty abatement, and general tax planning and controversy matters. Michael advises large U.S. and foreign multinationals regarding compliance with information reporting and withholding issues, as well as a range of other federal and state tax issues.

Michael completed a three-year term on the IRS Information Reporting Program Advisory Committee (IRPAC) in 2013, during which time he worked with the IRS on FATCA, the Affordable Care Act (ACA or Obamacare) reporting issues, tip reporting, Form 1099-K reporting issues, and civil penalty administration. He has testified before the U.S. Treasury Department and the IRS regarding proposed federal tax regulations.

Michael’s experience includes serving as Tax Manager for a publicly traded multinational, where he managed federal and state tax examinations and appeals, including matters involving foreign taxes. In addition, he performed domestic and international tax planning, including issues related to the repatriation of foreign earnings, U.S. export tax benefits, research credits, and planning for foreign expansion.

Michael has appeared as a guest speaker on IRS Live and at seminars hosted by Tax Executives Institute (TEI), Thomson Reuters OneSource, IRSCompliance, the American Payroll Association (APA), the Blue Cross and Blue Shield Association, the National Association of College and University Business Officers (NACUBO), and the National Restaurant Association.

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. Michael advises…

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. Michael 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.

Michael 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.

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

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