Traditional companies can run into problems because of unscrupulous conduct by third-party companies enlisted to provide temporary or leased employees. We will discuss this issue in part, along with many others, during a panel on criminal tax enforcement at the White Collar Practice Seminar of the Pennsylvania Association of Criminal Defense Attorneys (PACDL) this Thursday, November 12, at the Union League in downtown Philadelphia. My co-panelist will be Nanette Davis, a Senior Trial Attorney for the Criminal Enforcement Section of the DOJ Tax Division in Washington, D.C., who has tried some of the largest tax fraud cases ever prosecuted; our moderator will be Jim Becker, a distinguished white collar defense attorney at the law firm of Buchanan Ingersoll & Rooney. Although the panel also will discuss the DOJ’s Swiss bank program and offshore enforcement campaign, this blog discussion – broken up into two entries for today and tomorrow – will focus on the issue of employment tax enforcement, which is an announced enforcement priority, and employee leasing companies.
The IRS devotes part of its website to cataloguing prosecutions related to employment taxes. Here is one entry from the list for the 2015 fiscal year; it is quoted here in its entirety because there was a lot going on in the case, and because it lays out nicely the relevant issues:
On Dec. 11, 2014, in Philadelphia, Pennsylvania, Victor Thach was sentenced to 46 months in prison, three years of supervised release and ordered to pay $1,337,000 in restitution to the IRS. Thach previously pleaded guilty to 16 tax-related offenses, including conspiracy to defraud the United States and failure to collect, account for, and pay over taxes. According to court documents, between 2007 and 2009, Thach operated a 250-person labor leasing agency that supplied temporary workers (including manyOn Dec. 11, 2014, in Philadelphia, Pennsylvania, Victor Thach was sentenced to 46 months in prison, three years of supervised release and ordered to pay $1,337,000 in restitution to the IRS. Thach previously pleaded guilty to 16 tax-related offenses, including conspiracy to defraud the United States and failure to collect, account for, and pay over taxes. According to court documents, between 2007 and 2009, Thach operated a 250-person labor leasing agency that supplied temporary workers (including many illegal aliens) to local mail-sorting facilities. During this time period, Thach’s clients paid him more than $9.8 million for the labor he provided. Thach, in turn, paid his employees in cash and “under the table,” that is, without issuing IRS Forms W-2 or deducting any payroll taxes. Despite having a multi-million dollar payroll and counseling from two accountants separately about his tax and reporting obligations during the years in question, Thach did not file a single tax return (corporate or individual). By withholding federal income taxes and social security and Medicare taxes from the “under the table” wages, Thach caused a tax loss of at least $1,049,763. Thach also never accounted for or paid over to the IRS his employers’ matching share of the social security and Medicare taxes, totaling $454,996. Instead of paying the government, Thach spent tens of thousands of dollars gambling at high-end casinos in Atlantic City, the purchase a $59,000 Mercedes Benz SUV, made regular payments toward a $60,000 Hummer, traveled repeatedly to Cambodia, and wired more than $180,000 to accounts he controlled in Cambodia.
One of the more notable facts listed above is the sheer amount of money that the defendant’s leasing agency was paid by his clients, which presumably were entirely traditional and legal businesses. Although there is no indication – and no reason to believe – that these clients ever were suspected of participating in any criminality, it is not difficult to imagine fact patterns in which distinctions get blurred and companies using the common tool of labor leasing agencies themselves become caught up in some of the many possible legal problems that can face non-compliant agencies. Thus, even if you never can imagine yourself as someone who fails to file required tax returns, runs a cash payroll, and spends business proceeds on fancy cars rather than business obligations, doing business with such people still can result in their problems becoming your problems. Specifically, those potential problems can involve, among others: (i) civil tax issues; (ii) criminal tax issues; and (iii) immigration law issues. Today’s entry will discuss the first issue; tomorrow’s entry will discuss the latter two issues.
Civil Tax Issues.
A temporary staffing service (“TSS”) typically recruits, trains and pays its own employees, who it assigns to work for its client, another company, that pays the TSS a contractual fee. In this scenario, the TSS is both a “common law” employer and a “statutory” employer – concepts discussed below – and is therefore responsible for employment taxes. See Internal Revenue Manual (“IRM”) 188.8.131.52.1.1. In the above description of Mr. Thach’s case, it appears that his agency served as a TSS, presumably in a way that made it the employer solely responsible for the relevant payroll tax withholdings and payment. However, if the facts were different, some or all of his clients could have been deemed by the IRS to be employers that also were legally responsible for some or all of the approximately $1.5 million in employment taxes that never got paid – plus interest and penalties.
The IRS recognizes two types of employers: statutory and common law. For tax purposes, an employer may be both the statutory and common law employer; however, the statutory employer and common law employer are not necessarily the same.
For income tax withholding purposes, a statutory “employer” is defined by 26 U.S.C. § 3401(d)(1) as “the person for whom an individual performs or performed any service, of whatever nature, as the employee of that person, except that if the person for whom the individual performs or performed the services does not have control of the payment of the wages for such services, the term ‘employer’ means the person having control of the payment of such wages.” Id. (emphasis added). In 1974, the Supreme Court incorporated the definition of “employer” under 26 U.S.C. § 3401(d)(1) to the Federal Insurance Contributions Act (“FICA”). See Otte v. United States, 419 U.S. 43, 51 (1974). The federal circuit courts later applied the 26 U.S.C. § 3401(d)(1) definition of “employer” to the Federal Unemployment Tax Act (“FUTA”). See In re Armadillo Corp., 561 F.2d 1382, 1386 (10th Cir. 1977). The Internal Revenue Code (IRC) therefore makes a critical distinction in its definition of “employer”: if more than one potential employer exists, but only one controls payment of wages, then that employer will constitute exclusively the “employer” for the purposes of having the duty to withhold, report and pay employment taxes. Control of the payment of wages is the key.
Generally, a common law employer is “the person for whom services are performed [who] has the right to direct and control the individual who performs the services, not only as to the result to be accomplished by the work, but also as to the details and means by which that result is accomplished.” I.R.M. 184.108.40.206.1. To determine whether a common law employer-employee relationship exists, the IRS currently employs a test involving 11 factors (previously, the test had 20 factors) that are generally classified into three broad categories: behavioral control, financial control and relationship of the parties. See I.R.M. 220.127.116.11.1. No one factor is dispositive; the courts will weigh the specific facts and circumstances of each case. See Revenue Ruling 87-4, 1987-1 C.B. 296 and I.R.M. 18.104.22.168.1. Just like statutory employers, common law employers must withhold, report and pay the employees’ and employer’s share of FICA and FUTA taxes. However, if the common law employer is not in control of the payment of wages, the person who is in control is the employer responsible for withholding, reporting and paying the employee’s and employer’s FICA and FUTA taxes. See In re Laub Baking Co., 642 F.2d 196, 198 (6th Cir. 1981). Even if the company that is paying the TSS is considered the common law employer, because it exerted sufficient control over the employees, a TSS that remains the statutory employer will remain responsible solely for the FICA and FUTA taxes. See Cencast Servs., L.P. vs. United States, 729 F.3d 1352, 1356 (9th Cir. 2011). Conversely, if the company that is paying the TSS is determined to be the statutory employer, because it had legal control of the payment of wages, then that company also will be responsible for employment taxes. See Winstead v. United States, 109 F.3d 989, 992 (4th Cir. 1997). Again, control of the payment of the employees’ wages is the critical question. This is because “[i]t matters little who hired the wage earner or what his duties were or how responsible he may have been to his common law employer. . . . When it finally comes to the point of deducting from the wages earned that which part belongs to the United States and matching it with the employer’s share of FICA taxes, the only person who can do that is the person who is ‘in control of the payment of wages.’” Id.
Accordingly, if Mr. Thach’s agency did not have total control over the payment of the workers’ compensation, his clients could have shared his tax obligations. Although that would not have relieved Mr. Thach of his own criminal and civil liabilities, it would have spelled possible problems for his clients, which presumably had more assets available for IRS collection.
In a post to follow, I’ll continue to examine the case of Mr. Victor Thach and the problems that can arise for a business dealing with a temporary staffing service, or “TSS,” that is violating the law.