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Payroll Outsourcing, Part 1: Do Employers Remain Responsible for Taxes?

Payroll taxes take a lot of work to administer properly. Calculating Social Security, Medicare and other taxes is only the start. There is also the need to withhold proper amounts and to make required reports and deposits to the IRS.

It therefore makes good business sense for many businesses to use third-party providers to handle their payroll services. But what happens when such a provider commits fraud or goes out of business? In this post, we will discuss the responsibility that employers have for tax compliance when outsourcing payroll duties to a third party.

The short answer is that businesses that make use of third-party payroll services may still be responsible for the taxes the third-party was supposed to handle for them. To be sure, there are several qualifications to this statement. It depends on the exact nature of the third-party arrangement, as well as the particular facts of each case.

But employers who outsource payroll should be aware that if a third-party provider fails to make required payments to the IRS, the IRS may still seek to collect the taxes that are owed from the business that did the outsourcing.

A recent tax fraud case in the Midwest illustrates what can happen to businesses in such circumstances. The proprietor of a payroll processing service skimmed about $700,000 from the $2 million in employment taxes that had been withheld for payment to the IRS.

An IRS criminal investigation disclosed the fraud that led to criminal charges. The man who skimmed the money from the withholding account ended up with a 78-month federal prison sentence. The company that he victimized was left to deal with the IRS about the tax payments that hadn't been made.

The IRS asserts that it is open to working with victims in cases like this through payment plans or the possibility of penalty abatement. But if you have been victimized by a third-party provider, it is important to get counsel from an experienced tax attorney as you consider your options for resolving the tax debt.

In part two of this post, we will discuss the different types of third-party arrangements that are available to businesses for handling payroll tax obligations.

Source: IRS.gov, "Outsourcing Payroll and Third Party Payers"

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