Employment tax compliance: why the stakes are so high

Employment taxes pose multiple challenges for businesses.

One of these challenges is that decisions about how to classify workers -- as employees or as independent contractors -- create dilemmas for businesses. Another is that failure to pay employment taxes can lead to civil fines and even criminal prosecution. In this post, we will take note of both of these aspects of employment tax compliance for businesses.

Worker Classification and Payroll Taxes

As a business owner, you know there are often sound business reasons to make use of contractors. Doing this gives you more flexibility in the structure of your workforce and allows you to control costs by avoiding the payment of pricey benefits packages.

But if worker classification is not done correctly, you could face serious compliance concerns regarding employment taxes. These issues are best addressed with counsel from a knowledgeable tax attorney.

For the past few years, the IRS has conducted many employment tax audits around the country. These audits could also be called payroll tax audits, as the terms "employment taxes" and "payroll taxes" are largely synonymous.

If an employment tax audit finds that workers were misclassified as contractors, the IRS can impose civil penalties for several different violations. These violations include failure to withhold taxes from workers' wages and failure to make employment tax payments.

Failure To Pay Employment Taxes

But it isn't only civil penalties against the company that may be at issue when the IRS scrutinizes employers' classification decisions and overall compliance with employment tax obligations. Under the Trust Fund Recovery Penalty, the IRS may seek to hold business owners and officers personally accountable for certain unpaid payroll taxes.

When misclassification by an employer is considered willful, there is also the possibility of criminal charges. Such charges are also possible in other contexts for failure to pay employment taxes, even if classification is not an issue.

Possible fines or even criminal charges for employment tax noncompliance are hardly abstractions, either. As Forbes reported recently, the IRS imposed nearly $5 billion in civil penalties last year. The IRS also launched about 120 criminal investigations relating to employment taxes.

In a recent case, U.S. v. Harrison, a federal appeals court upheld a federal prison sentence for an employer who failed to pay over $40 million in employment taxes. We will discuss that case in greater detail in an upcoming post.

Given this background, it is scarcely surprising that many business owners have taken advantage of an IRS initiative called the Voluntary Classification Resettlement Program (VCSP). We will discuss the VCSP in more detail in an upcoming post.