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Small Business Owner? Behind on Payroll Tax? You may be Committing a Federal Crime.

Michael S. Anderson Dec. 12, 2013

The Internal Revenue Code (IRC) at 26 U.S.C. Sect. 7202 makes the willful failure to collect, account for, and pay over employment tax a felony.

26 U.S.C. Sect. 7215 makes it a misdemeanor for simply failing to pay the money collected.

Yes…it is a misdemeanor to collect FICA and Income Tax from your employee and not send it the IRS.

Fortunately the IRS doesn't a make this crime a priority because it is under-staffed.

Yes…it is a felony to willfully fail to collect, account for or pay it to the IRS.

And yes…the IRS focuses it criminal effort on the felony cases and routinely charges small business owners with a crime under 26 U.S.C. Sect. 7202. When it does, it also routinely gets convictions.

A few very recent examples:

In July, Michael and Laurie Russell of Hickman Nebraska were sentenced to 16 months and 6 months, and ordered to pay restitution to the IRS of more than $311,000.00. They were convicted of “failing to pay that amount in tax and withholdings of their employees for 2006 when they owned North County Windows Inc. of Lincoln”.

Last month, a man from Bear, Delaware was sentenced to 30 months after he plead guilty to keeping money withheld from his employees' payroll taxes.

In October here in Arizona, the Lam Brothers plead guilty to charges that included evasion of payroll taxes.

If you are a small business owner and if you are having some payroll tax problems, you should be aware of a few things:

1. The duty to collect and pay falls on the employer

The duty to collect the tax from the employee, account for it, and to make sure the IRS gets the money, falls on the employer. It can't be delegated away to someone else. This doesn't mean that you have to calculate the payroll and drop the check in the mail yourself…it just means that you need to make sure it is being done right.

2. The duties to withhold, account for, and pay aren't separable

The breach of any one of these duties is an offense under 7202; you don't have to fail to do all three.

3. The IRS doesn't have to prove that an overt act was taken

7202 doesn't require any proof that an affirmative or overt act was taken. For example, the IRS doesn't have to prove that you took the money and moved it into an offshore account for your retirement.

If you simply pay business creditors and the tax doesn't get paid, the willfulness element of 7202 can be established, and the crime charged can move from a misdemeanor to a felony.

4. A crime under 7202 or 7215 applies only to fiduciary tax but other crimes may be charged

These employee taxes are called “Fiduciary” taxes because you are simply the caretaker. You aren't the caretaker in the same sense when it comes to your (the employer's) matching portion of the FICA tax. However, failing to pay the employer's portion can be charged as tax evasion under IRC Sect. 7201 or at a minimum, can be treated as relevant for sentencing purposes.

5. There are some types of activities that increase the risk of a criminal charge

a. Recidivism

If you have opened a number of businesses that have failed to account for, collect or pay this fiduciary tax, the IRS is looking more closely at you.

b. Personal Benefit

A person who is making a good income while not making sure the tax is paid, is also a greater target.

c. Toys

Fancy cars, boats, planes or other “Toys” will raise some eyebrows and increase the odds that you are charged with a crime.

d. Claim Benefits on your personal Return

If the fiduciary tax didn't make it the IRS, but you claimed that you paid the tax on your personal return, this is a big red flag.

6. Penalties

The penalties for violating IRC Sect. 7202 pursuant to 18 USC Sect 3571 are:

a. Fines up to $250,000.00 for individuals

b. Incarceration up to 5 years

c. The costs of prosecution

If you own a small business and are having a hard time paying all the business expenses, yourself and these fiduciary taxes, have a good CPA review your numbers immediately. It may be better to let the business go, than to continue to ignore payroll tax problems.