IRSWatch Outsourcing Closely

December 21, 2004
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DETROIT — The IRS says it's not trying to spoil the holiday mood, but some recent tax cases led its Michigan office to issue a warning to firms that may be considering payroll outsourcing.

Not that the agency wants to discourage the practice.

But it stresses that employers that for the first time are considering the step should bear one important fact in mind: When an employer sheds office hassles by retaining a third-party payroll specialist, the employer does not shed its legal tax responsibility to the IRS.

According to the IRS, the employer is directly responsible for the deposit and payment of federal taxes, though the third-party specialist actually makes the deposits. And should a third-party specialist fail to make a required deposit with the IRS, the IRS starts its inquiry with the employer, not the specialist.

In that connection, the IRS strongly suggests that the employer's address not be changed to that of the payroll service provider. Doing so, the agency said, could inadvertently prevent the employer from learning of tax problems — and, in dealing with the IRS, time can equal money — penalty money.

The Detroit IRS office says some recent prosecutions have involved people or firms who, acting under the guise of a payroll service provider, stole funds intended for payment of employment taxes.

And regardless of the cases' outcomes, the IRS stressed, federal law regards the defrauded employers as still liable for all taxes, penalties and interest due.

Such is the case, even though the employer in good faith turned over to the fraudulent third-party provider funds to satisfy federal tax obligations.

In such cases, the employer's principals — though innocent of any wrong-doing or intent — also could be held personally liable for certain unpaid tax obligations.

With that in mind, the IRS offers some recommendations to employers who want to streamline internal operations by farming out some payroll and tax functions to third-party providers.

  • Visit IRS.gov and type in the key words "employment tax enforcement."

  • Ask the payroll service provider to have a fiduciary bond in place that could protect the employer in a default.

  • Ask the service provider to enroll in and use the Electronic Federal Tax Payment System, so the employer receives immediate confirmation of payments made on its behalf. The system maintains business payment histories for online viewing for 16 months.
  • That employers verify EFTPS payments as a routine part of their bank account reconciliation process.          

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