Internal Revenue Service Taking Steps to Monitor and Control Payroll Service Providers

The Treasury Inspector General for Tax Administration or “TIGTA” audits Internal Revenue Service’s processes and programs on a regular basis.  TIGTA then issues audit reports identifying problem areas and suggests methods to improve those processes.

Recently, TIGTA issued a report noting that several payroll providers have been noncompliant with payroll tax payments and payroll filing requirements. In other words, they have impounded federal payroll taxes on behalf of their employer-client and failed to remit them to the Internal Revenue Service. Due to these failures and the risk of tax fraud, TIGTA suggested that new processes should be implemented by the Internal Revenue Service to directly connect third party payers to employers.

TIGTA divided third party payers into four categories:

  1. Payroll Service Providers, or “PSPs”, were further subdivided into two types: (a) Basic PSPs that prepare signature-ready federal payroll tax returns (or Forms 941) for employers to sign and file themselves, and (b) PSPs that also impound and remit employers’ payroll taxes directly to the Internal Revenue Service;
  2. Reporting Agents, which are common payroll service companies, that are a type of PSP, and must file Form 8655 with Internal Revenue Service, process payroll tax returns, sign as Reporting Agents, and impound and pay payroll taxes;
  3. “Section 3504” agents, who must file Form 2678 with Internal Revenue Service, report an aggregate payroll tax return, and withhold and remit payroll taxes to the Internal Revenue Service; and
  4. Professional Employer Organizations, or “PEOs,” that impound and pay payroll taxes and file payroll tax returns with the PEO’s own Federal Employer Identification Number (FEIN).

TIGTA noted in its audit report that Internal Revenue Service has not established appropriate internal or external procedures to connect employers with their payroll service providers.  So, TIGTA has made several recommendations to the Internal Revenue Service to improve those procedures, including the following:

  1. Internal Revenue Service should partner with the Bureau of the Fiscal Service and create a procedure to implement the existing Electronic Federal Tax Payment System (or “EFTPS”) to connect a PSP with an employer. The IRS has agreed with this recommendation.
  2. Internal Revenue Service should establish a new program requiring employers to inform Internal Revenue Service of their PEO relationship and establish a certified PEO system. The IRS partially agreed with this recommendation, but claimed it lacks funds to enforce such a program.
  3. PEOs should attach a Schedule R (detailing all of the individual employer clients) to its quarterly-filed Form 941. Internal Revenue Service does not believe it has the statutory authority to require that Schedule R with non-certified PEOs.
  4. Internal Revenue Service’s Wage and Investment Division should establish an internal program to ensure that Forms 8655 are accurately captured in Internal Revenue Service’s system. Internal Revenue Service has agreed with this recommendation, which should alleviate most problems experienced by PSPs in working with Internal Revenue Service employees to resolve employer payroll tax controversies.

Once Internal Revenue Service implements these recommendations, payroll tax fraud and payroll tax problems can be avoided resulting in minimizing or eliminating payroll tax penalties and interest.  These changes will be a pleasant surprise for employers who contract with PSPs for their payroll tax needs.

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    Howard L. Richshafer

    Howard Richshafer joined Wood + Lamping in 2008, and his practice is focused on civil and criminal tax problems, estate planning and probate, tax court trial work, mergers and acquisitions, and general corporate business matters. Howard is also a licensed Ohio CPA. Over the past 40 years, Howard has represented clients experiencing all types of civil and criminal tax problems with IRS. Those problems include IRS audits, IRS criminal investigations, enforced collection of unpaid tax liabilities involving levies, liens, and seizures of assets and income.

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