Recent TIGTA Report on Criminal Enforcement Against Employment Tax Noncompliance Criticizes IRS for Ineffectively Addressing Employment Tax Crimes, Offers Lessons to Employers/Responsible Parties Under Audit or In IRS Collections

On March 21, 2017, the Treasury Inspector General for Tax Administration (TIGTA) issued a report titled, “A More Focused Strategy Is Needed to Effectively Address Egregious Employment Tax Crimes.” The Report noted that, as of December, 2015, 1.4 million employers owed approximately $45.6 billion in unpaid employment taxes, interest, and penalties. The report indicated that in 2015, the IRS assessed the TFRP against 38% fewer responsible persons than just five years before (asserting the TFRP against just 11% of responsible individuals), and that simultaneously the number of employers with egregious employment tax noncompliance (20 or more quarters of delinquent employment taxes) has tripled in a 17-year period. TIGTA was concerned that, despite this noncompliance, there are fewer than 100 criminal convictions for employment tax violations per year.

TIGTA recommended a focused strategy to improve the IRS’s efforts to address egregious employment tax cases, to include “use of data analytics to better target egregious employment tax noncompliance, including identification of high-dollar cases and individuals with multiple companies that are noncompliant. In addition, the Collection function should expand the criteria used to refer potentially criminal employment tax cases to CI to include any egregious cases (not only those where a firm indication of fraud is present).”

The following is what IRS stated in response to TIGTA’s conclusions:

The Collection function refers cases when firm indications of fraud/willfulness are present and they meet criminal criteria.  IRS § 7202 is considered and referred to as a tax fraud statute, and therefore the criteria used to criminally prosecute employment tax cases to CI under § 7202 require the Service to prove the willfulness standard that the taxpayer committed “a voluntary, intentional violation of a known legal duty.”  That level of fraud/willfulness (known as “mens rea”) is the key differentiation between civil and criminal cases.  Cases that do not meet this standard should continue to be pursued under applicable civil remedies.

The Report also makes clear that, according to Collection procedures, employment tax cases will not be referred to CI unless firm indications of fraud exist and “must establish that a particular action was deliberately done for the purpose of deceit, subterfuge, camouflage, concealment, some attempt to color or obscure events, or to make things seem other than what they are.”

According to the Report, CI considers multiple factors when deciding whether or not to initiate an investigation, which include deterrence, willfulness, and jury appeal. The TIGTA report also offers some key data on the source of criminal employment tax referrals. Referrals are generated where IRS Revenue Officers or Revenue Agents identify indicators of fraud, which constitutes approximately half of all employment tax investigations over the last five years.

Although the IRS has not agreed to make any changes in response to the TIGTA report, based upon recent DOJ prosecutions and press releases, along with DOJ’s public announcements about the priority of employment tax prosecutions (and civil injunctions), it is clear that the IRS will continue to consider criminal referral in employment tax cases that warrant it. Judging from recent DOJ prosecutions, cases are most likely to lead to a criminal referral where (1) there was personal benefit to the responsible party/employer as a result of the non-payment of the employment taxes; (2) there is pyramiding of liabilities and/or employers accrue employment taxes then shut down the business to start another one; and (3) employers filed false employment tax returns not reporting the majority of employees and/or reflecting less payroll liability than owed. These categories are not exhaustive but they reflect recent trends in prosecutions.

Employers and responsible parties should be aware of the evidence of “willfulness” that is often utilized in criminal employment tax prosecutions: early alerts; Letter 903; Forms 4180 (trust fund recovery penalty form and corresponding interview); prior non-compliance; false collection/financial information provided to IRS on Forms 433. It is important to approach the process at the outset with these issues in mind. Employers and responsible parties undergoing an employment tax audit or in IRS Collections should be aware of these priorities and should seek counsel when necessary.