It’s an old story that the IRS combats everyday: When a business struggles and cash flow is tight, when there is not enough money to pay both rent and employment taxes, the IRS takes a back seat, and the business uses employee withholding taxes to keep the lights on.
The result is that the IRS is made an unwilling lender to fund operations. Your hope is that the tide will turn and the IRS can be repaid before they come calling. Your business is your baby, but this is can be a dangerous bet, and as we will see, it is especially dangerous in employment tax cases.
Liability for employment taxes does not just stay with the business; rather, the IRS spreads it to you, too – the business owners, officers, and even employees – anyone who had decision-making power over the company’s finances can be personally liable for a part of the unpaid taxes. This is called a trust fund recovery penalty investigation.
Simply put, unpaid employment withholding taxes are a cancer.
As the IRS casts a wide net to collect employment taxes, a three-tiered defense is usually required: to the initial collection of the employment taxes from the business (Tier-1); to the ensuing trust fund recovery penalty investigation into who in the company made the decisions not to pay the IRS (Tier-2); and to the eventual collection of the trust fund taxes from those in the business who were responsible for the decisions not to pay the IRS (Tier-3).
The best employment tax defense will recognize each step the IRS will pursue in advance, will see what is coming, and will prepare for it. With that background, here is the IRS’s step-by-step game plan in a civil employment tax investigation.
STEP 1. ASSIGNMENT OF AN IRS REVENUE OFFICER TO COLLECT THE TAXES FROM THE BUSINESS.
The IRS considers employment tax liabilities to be a serious matter, and as a result, will assign an employment tax case to its highest level collection personnel, a Revenue Officer.
Chances are, the first move the Revenue Officer will make is to have an unannounced visit your business. Expect the Revenue Officer to drop off her business card, along with (1) ) Form 9297, Summary of Taxpayer Contact and (2) Letter 1058, Final Notice of Intent to Levy and Notice of Your Right to a Hearing.
The Revenue Officer’s initial knock on the door is to collect the employment taxes from your business. That will soon change.
You do not know it yet, but the Revenue Officer does not intend to just investigate collection of the employment taxes from your business. The Revenue Officer will also be launching an investigation into the operations of the business. The investigation will be focused on control over company finances: Who had the decision-making authority that resulted in the employee withholding taxes not being paid to the government? That could be you, that could be your CEO, a co-owner, or your spouse.
This is called a trust fund recovery penalty investigation. It permits the IRS to collect part of the unpaid employment taxes personally from the individuals who were in control of the business and were able to make financial decisions to not pay the IRS.