The Internal Revenue Service (search) on Monday urged employees to watch for and businesses to avoid payroll tax evasion.
Federal law requires employers to withhold certain taxes from their employees' paychecks and send the money to the IRS every three months. Taxes collected include federal income tax and Social Security (search) and Medicare (search) taxes. Businesses also must pay unemployment tax.
Employers face criminal and civil penalties, including fines and prison, if they fail to pay employment taxes.
"Failure to pay employment taxes is stealing from the employees of the business," said IRS Commissioner Mark Everson.
An employee cannot contact the IRS to determine whether an employer remitted taxes withheld from paychecks. Workers can check paycheck stubs for lines reporting the withheld taxes, and employees also should see withholdings reported on their annual W-2 wage and tax statements.
Employees whose employers do not pay the taxes or report them improperly might find it difficult later to claim their Social Security, Medicare or unemployment benefits.
These are the most common types of employment tax evasion:
- Pyramiding. An employer collects unemployment taxes but uses the money to cover other business expenses. Unpaid taxes accumulate until the employer cannot catch up. The business closes or enters bankruptcy.
- Unreliable third-party payers. A company hired to process payroll for a business fails to hand over employment taxes. The IRS urges businesses to select and monitor carefully the companies they hire to handle payrolls.
- Frivolous arguments. Businesses or employees argue improperly that federal law doesn't require them to submit payroll taxes. Courts have struck down these arguments repeatedly.
- Offshore employee leasing. Offshore leasing companies arrange for employees to leave their jobs, then return under a contract arranged by the leasing company. The employees' salaries are paid into offshore accounts and considered deferred compensation. Promoters improperly claim that no taxes are owed on the money paid as deferred compensation. The IRS has targeted promoters and employees who used this arrangement.
- Misclassifying worker status. Employers improperly treat employees as independent contractors to avoid paying employment taxes.
- Paying employees in cash. Businesses can legally pay their employees in cash. Some pay cash to avoid creating a payroll paper trail and avoid employment taxes. The IRS said it needs no payroll records or checks to prove payroll tax evasion.
- Filing false payroll returns or no payroll returns. Employers fail to file employment tax returns to the IRS or file false returns that intentionally understate wages paid to their employees and taxes owed.
- Executive compensation treated as corporate distributions. Some small businesses improperly treat payments to officers as corporation distributions, instead of wages or salaries.
Employees with concerns about an employer can contact the IRS at 1-800-829-1040 or report suspected tax fraud by calling 1-800-829-0433.