Today’s guest blogger, Mary Gorman, worked with me in the Office of Chief Counsel, IRS for many years and became an expert on employment tax issues there. Today she discusses a new and long needed regulation that will impact what I used to call employee leasing companies. As the common law employer moved away from the direct role as employer and new companies entered the scene as intermediaries, the IRS encountered more and more problems over the past two decades when payroll taxes were not paid. The regulations give the IRS another tool in its efforts to collect unpaid payroll taxes. Keith
On April 14, 2014, the IRS finalized the third party payor regulations. These regulations create a new type of entity for payroll compliance, the “Payor to Perform Acts of an Employer”, (Payor Employer). This new entity will be jointly liable with the common law employer for any unpaid employment taxes. The proposed regulations had used the term “Payor as Agent to Perform Acts of an Employer”. In response to a comment on the proposed regulations, IRS removed the term Agent. It is probable that these regulations will function as a “collection tool”. They will be used when taxes are unpaid and the IRS needs to assert joint liability since the regulations do not impose any unique reporting requirements for an entity that meets the definition of Payor Employer.
This new type of payroll entity should encompass employee leasing companies. A Professional Employer Organizations (PEO) is an entity that hires and leases employees to workplace employers. PEOs hold themselves out as the employer. They file the Forms 941 in their own name and Employer Identification Number (EIN). If the PEO leases employees to multiple worksite employers, the PEO will file an aggregate return, treating all leased employees as the PEO’s employees and will make aggregate deposits for these liabilities. When those taxes go unpaid, the IRS and the worksite employers have problems, not the least of which is determining which clients’ taxes have gone unpaid when there was aggregate reporting and aggregate deposits.read more...
First issue has been whether the PEO is liable for the unpaid taxes. The Internal Revenue Code attaches liability for employment taxes to the employer. Sections 31.3102-1 (d), 31.3202-1 (e), 31.3301-1 and 31.3403-1 establish that the employer is the person liable for the withholding and payment of employment taxes, whether or not amounts are actually withheld.
Common Law Employer?
It is rare that a PEO would be the common law employer. The PEO client, the worksite employer, is generally always the entity with the power to direct and control the workers. The proposed regs provide:
Under the common law test, an employment relationship exists when the person for whom the services are performed has the right to control and direct 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. An employment relationship exists if an employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if the employer has the right to do so. See §§31.3121 (d)-1 (c), 31.3231 (b)-1 (a) (2), 31.3306 (i)-1 (b), and 31.3401 (c)-1 (b). This test is also applicable in determining which of two parties in a three-party arrangement is the employer. See for example, Professional and Executive Leasing, Inc. v. Commissioner, 89 T.C. 225 (1987), aff’d, 862 F.2d 751 (9th Cir. 1988)
Joint or Co-Employer?
Federal employment tax law does not recognize co-employment or joint employment.
There is no definition of “co-employment” or “co-employer” for federal employment tax purposes. Nor does the Code, regulations, other formal guidance, or any binding court precedent recognize “co-employment” or “co-employer” for federal employment tax purposes. PLR 201347020
There is a Revenue Ruling from 1966 that is discussed in footnote 19 of the PLR, where the IRS recognized concurrent employment by two common law employers where both satisfied the common law direction and control test such that each was a common law employer of the sales clerks. Revenue Ruling 66-162.Statutory Employer or “mere conduit”?
Is the PEO the §3401(d)(1) employer? Section 3401 (d) (1) provides that for purposes of federal income tax withholding, the term employer means the person for whom an individual performs or performed any service, of whatever nature, as an employee of such person, except that, if the person for whom the individual performs or performed the services does not have control of the payment of wages for such services, the term employer means the person having control of the payment of such wages.
What does “in control of the payment of the wages” mean? It means legal control. If the PEO is paid the wages and the taxes by the client before the PEO pays the employees, IRS has said that the PEO is a mere conduit for the wages and is not in legal control of the wage payments. IRS appears to be moving to a position that if the PEO is reimbursed after the wages were paid, than the PEO is in control of the payment of the wages.
To be a payroll agent under § 3504 of the Code, the entity must file a Form 2678 and be approved by the IRS as the agent for payroll. PEO’s do not file this form because they hold themselves out to be the employer. Payor to Perform Acts of an Employer
The new regulations create joint liability for any entity holding itself out as the employer if the entity is party to a service agreement that:
- asserts it [the payor entity] is the employer (or “co-employer”) of the individual(s) performing services for the client;
- pays wages or compensation to the individual(s) for services the individual(s) perform for the client; and
- assumes responsibility to collect, report, and pay, or assumes liability for, any taxes applicable under subtitle C of the Code with respect to the wages or compensation paid by the payor to the individual(s) performing services for the client.
If a payor is designated to perform the acts required of an employer under this section then the following rules apply:
- A payor must perform the acts required of an employer under each applicable chapter of the Code and the relevant regulations with respect to the wages or compensation paid by such payor.
- All provisions of law (including penalties) and the regulations applicable to the employer are applicable to the payor so designated with respect to the wages or compensation paid by the payor; and
- Each employer for whom the payor is designated remains subject to all provisions of law (including penalties) and of the regulations applicable to an employer.
A payor is not considered a payor employer that has been designated to perform the acts required of an employer under this section for any wages or compensation paid by the payor to the individual(s) performing services for a client if:
(1) the wages or compensation are reported on a return filed under the client’s employer identification number (as defined in section 6109 and the applicable regulations);
(2) the payor is a common paymaster under sections 3121 (s) or 3231 (i);
(3)the payor is the employer of the individual(s) (including an employer within the meaning of section 3401 (d) (1)); or
(4) the payor is treated as an employer under section 3121 (a) (2) (A) [sick pay].
Treas. Reg. §31.3504(e) has 9 examples showing the application of these regulations. Example 1 is as follows:
- Example 1. Corporation P enters into an agreement with Employer, effective January 1, 2015. Under the agreement, Corporation P hires the Employer’s employees as its own employees and provides them back to Employer to perform services for Employer. Corporation P also assumes responsibility to make payment of the individuals’ wages and for the collection, reporting, and payment of applicable taxes. For all pay periods in 2015, Employer provides Corporation P with an amount equal to the gross payroll (that is, wage and tax amounts) of the individuals, and Corporation P pays wages (less the applicable withholding) to the individuals performing services for Employer. Corporation P also reports the wage and tax amounts on Form 941, Employer’s QUARTERLY Federal Tax Return, filed for each quarter of 2015 under Corporation P’s employer identification number. Corporation P is not a common paymaster, the employer of the individuals (including an employer within the meaning of section 3401 (d) (1)), [*15] or treated as the employer of the individual under section 3121 (a) (2) (A). Corporation P is designated to perform the acts of an employer with respect to all of the wages Corporation P paid to the individuals performing services for Employer for all quarters of 2015. Employer and Corporation P are each subject to all provisions of law (including penalties) applicable in respect of employers for all quarters of 2015 with respect to such wages.
IRS Audit Memo dated May 8, 2014.
On May 8, 2014, the IRS issued an Interim Guidance Memo (IGM) number SBSE-04-0514-0036. The purpose of the memo is to identify when employers use a third party to withhold, file, and pay their employees such as a Payroll Service Provider, Reporting Agent, a Section 31.3504-1 Agent with an approved Form 2678, or an employee leasing entity (a Professional Employer Organization, PEO).
During the audit of an employer that uses the services of a third party, the examiner must inform the employer that it is not relieved of the responsibility to ensure that its tax returns are filed timely, and that taxes are deposited or paid correctly and timely.
Additionally, the examiner must instruct the employer to take actions to determine that its filing and payment responsibilities are met.
For employers that use Payroll Services Providers or Reporting agents where the Forms 941 are filed in the name and EIN of the employer, as part of the audit, the employer will be instructed to:
º Verify its employer address is the address on record with the IRS, not the address of the PSP or RA. Examiners must check IDRS and inform the employer which address we have on file. Further, the examiner should instruct the employer that it could verify the address of record by calling the IRS Business and Specialty Tax Line at (800) 829-4933. º Verify the PSP or RA uses the Electronic Federal Tax Payment System (EFTPS) when making employment tax deposits and payments. º The employer will be instructed to enroll in EFTPS so the employer can view EFTPS deposits and payments made on its behalf under its EIN. Information about enrolling on EFTPS is located at www.eftps.gov. Effective January 2014, EFTPS will be issuing Inquiry PINs to all employers who are registered on EFTPS by their TPPs. Inquiry PINs allow employers to view their deposit history without a separate EFTPS enrollment. Employers that use 31.3504-1 agents, who file the Forms 941 in their own name and EIN and not those of the employer, will be advised, as part of the audit, that:
- the employer that it remains liable along with the agent.
- the employer must use due diligence in requesting authorization from the IRS to appoint an agent on Form 2678, and continuing to use the agent after the authorization is approved.
Employers that use PEOs who also file the Forms 941 in their own name and EIN and not those of the employer, will be advised, as part of the audit, that:
- the employer must use due diligence in selecting and continuing to use the services of any PEO.
- Further, Examiners auditing an employer who is using a PEO must also contact Judith ‘Judy’ Davis of Specialty Programs, Employment Tax, via e-mail. Examiners must provide Judy with the following information: º Name and EIN of client º Tax Periods under examination º Name and EIN of PEO
While these regulations give the IRS a second collection source, the PEO, these employee leasing entities generally do not have significant assets. The common law employer, who paid over his tax money to the PEO, will still be jointly liable for the unpaid taxes. It also doesn’t solve the aggregate deposits and filing problems. When a PEO doesn’t pay or doesn’t full pay the employment taxes for its clients, there will still be the issue of which employer’s taxes have gone unpaid. What would help the aggregation problem is if the IRS would require any entity that meets the definition of Payor Employer, to file the Schedule R with their Forms 941. The Schedule R would require the Payor Employer to show the wages, taxes and deposits separately for each client. The deposits would be identified for each specific client, and the IRS and the common law employer could use this information to determine how much is owed by each client (although this still leaves the problem of credits and refunds that were sent back to the PEO, since those were also aggregate amounts. )
For anyone wanting more background on this, look the Proposed Regulations (REG. 102966-10). The Preamble contains an extensive discussion of the IRS’ position regarding all variations of third party payroll entities and how IRS will analyze third party payroll situations.