Employment Tax Fraud
Federal law requires employment tax withholding and payment by employers. Failure to do so can be considered tax fraud, and violators may face both civil and criminal penalties.
Employment taxes consist of:
- Federal income tax withholding
- Social Security taxes
- Medicare taxes
- Unemployment taxes
Some states also have withholding requirements for other employment-related taxes such as contributions to a worker’s compensation fund.
Common Employment Tax Fraud Schemes
- Pyramiding – A business withholds taxes from its employees but intentionally fails to pay them to the IRS. As these quarterly tax withholdings accumulate, or “pyramid,” it becomes increasingly difficult for the employer to catch up on back taxes, often resulting in bankruptcy.
- Unreliable Third Party Payers –This scheme generally involves either payroll service providers or professional employer organizations who fail to pay collected employment taxes to the IRS.
- Frivolous Arguments – Employers may use a variety of false or misleading arguments to avoid paying employment taxes. Many of these schemes are based on manipulating “Section 861” of the tax law.
- Off-Shore Employee Leasing – A taxpayer resigns from his current employment position and signs an employment contract with an off-shore employee leasing company, who indirectly leases his services back to his original employer. The employee performs the same services before and after entering into the leasing agreement and generally receives the same payment for his services. However, his salary is sent off-shore as “deferred” compensation, where employment and income taxes are potentially avoided.
- Misclassifying Worker Status – An employer incorrectly treats an employee as an independent contractor to avoid paying employment taxes.
- Cash Payments – Employers often pay employees in cash to avoid reporting the income and paying the appropriate employment taxes.
- Payroll Tax Return Schemes – An employer files false payroll tax returns or fails to file payroll tax returns altogether.
- S Corporation Officer Compensation Treated as Corporate Distributions – S Corporations sometimes improperly treat officer compensation as corporate distribution instead of wages or salary to avoid paying employment taxes.