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What Happens to Employees When the Employer Fails to Pay Over to the Government Withheld Taxes

Posted on May 3, 2022

In Plazzi v. FedEx Ground Package System, Inc., No. 1:21:-cv-12130 (D. Mass. 2022), three employees sued their employer because their withheld wages were not paid over to the government.  I do not remember seeing such a suit previously, but this is a matter that I discuss with my students each semester.  Most of us pay taxes through third-party intermediaries.  Understanding the relationship between the third-party intermediary and you, the taxpayer, and the government is important.  The case provides a nice analysis of what I explain to my students each semester.  In addition to explaining how the system works, the court dismisses the complaint, finding that it is barred by statute.  If you are looking for a good explanation of how the third-party intermediary system of tax payment works, this relatively short opinion offers it up.

At some point each semester I ask the students if they have ever worked as an employee.  Almost all say yes.  I then ask what happens if their employer does not pay over the withheld taxes and how many of them checked to make sure their employer actually paid over to the government the taxes it withheld from their wages.  The students have almost never thought about what happens to their withheld wages and some have a concerned look as they begin to think about the possibility of the failure of their employer to send to the government the amount taken from their wages.  Usually, after a bit of mild prompting, at least one of the students will express the view that the responsibility for failing to pay over the withheld taxes should fall on the employer and not the individual.  We then discuss why it should work that way and a look of relief comes over those who began to have concerns.

Mr. Plazzi and the others who brought this suit had not had the opportunity to have such a discussion. I understand why they would have concerns. I am puzzled that they did not find a lawyer who could explain the way the system works to them before they went to the trouble to file the suit.

Major corporations like FedEx basically never fail to pay over the taxes they withheld. So, I was a little surprised to see FedEx as the defendant in such a suit. The failure to pay over trust fund taxes regularly occurs in small businesses with cash flow problems usually run by an individual or a small group of individuals who are all in financially. Executives of a major corporation should never put themselves in this position.

My surprise lifted as the court explained the facts.  Apparently, FedEx contracts with independent companies to deliver packages in some areas.  Learning this should not surprise me.  The US Postal Service does the same thing as do many other large enterprises.  Mr. Plazzi and his fellow plaintiffs worked for Eloah Delivery rather than directly for FedEx.  The court described the arrangement as follows:

Eloah was an “independent service provider” (“ISP”) of FedEx. ISPs typically handle three or more FedEx delivery routes and follow FedEx’s policies and procedures. FedEx maintains strict control over the way in which Plaintiffs and other delivery drivers working under ISPs perform their work. Delivery drivers hired by FedEx ISPs are classified as “employees” of the ISPs. For example, under its ISP Agreement with FedEx, Eloah agreed that it would “assign only Personnel, including officers and managers, that [Eloah] ensures are treated as employees of [Eloah] in the provision of Services under this Agreement.” Further, Eloah agreed under the ISP Agreement to “assume sole responsibility for payroll deductions and maintenance of payroll and employment records, and for compliance with Applicable Law, including . . . wage payment, final payment of wages, required withholdings from wages, deductions, overtime, and rest and meal periods.”

Like many small businesses, Eloah withheld taxes from its employees’ wages as required; however, it did not pay over the withheld taxes to the government. Somehow, unexplained in the opinion, plaintiffs found out about this failure. Plaintiffs argued that FedEx violated their rights under the Massachusetts Wage Act. FedEx countered that their claim is barred by state and federal law. In finding for FedEx, the court explained why such a claim is barred.

While I say that it was unexplained in the opinion how the employees knew the money was not paid over to the IRS, the opinion did provide an explanation of how they knew problems existed.

Prado [the supervisor at the company] told Plaintiffs he was withholding taxes equaling twenty-three percent of their gross pay per week. Plaintiffs were under the impression that Prado was withholding all required state and federal taxes and that they would receive a W-2 tax form from the Internal Revenue Service (“IRS”) reflecting their gross wages following the 2020 calendar year. Plaintiffs never received their W-2 forms.

So, these employees have even more problems than not having their wages withheld.  They also appear not to have a statement sent to the IRS (or Social Security) reflecting the amount paid to them and the amount withheld.  If an employer never files these forms, employees struggle to get credit.  A procedure exists for creating a substitute W-2 but that usually relies on paystubs or a statement from the company.  This is a major procedural problem by itself which can be compounded where an employer insists on making wage payments through a platform like Zelle or a similar middleman.  The lack of receipt of W-2s may have played a large role in their decision to bring a case though it is not resolved through the decision.

The employees get credit for the withheld taxes regardless of whether the employer pays the money over to the government, though proving the money was withheld can, in situations like this, prove difficult.  Assuming the employees can establish their wages were withheld, any fight about the unpaid taxes becomes a fight between the government and the employer (and potentially any responsible persons under IRC 6672) and not a fight between the employees and the employer.  In explaining this, the court stated:

Employees, however, are barred from suing employers for failing to pay withheld taxes to the IRS: the Internal Revenue Code provides that “[t]he employer shall be liable for the payment of the tax required to be deducted and withheld . . . and shall not be liable to any person for the amount of any such payment.” 26 U.S.C. § 3403. “[T]his statute makes clear that while . . . the employer may be penalized by IRS for failure to pay the tax to it, suits against it by employees for taxes withheld from the pay of such employees are statutorily barred.” Chandler, 520 F. Supp. at 1156 (dismissing employee’s suit against employer for alleged conversion of money withheld from employee’s paycheck); see Bright v. Bechtel Petroleum, Inc., 780 F.2d 766, 770 (9th Cir. 1986) (citing Chandler, 520 F. Supp. at 1156) (affirming dismissal of claim seeking to recover withheld income tax as “statutorily barred”); Haggert v. Philips Med. Sys., Inc., No. 91-cv-30060-MAP, 1994 WL 673508, at *2 (D. Mass. Mar. 24, 1994), aff’d, 39 F.3d 1166 (1st Cir. 1994) (dismissing similar claim on same grounds). Similarly, Massachusetts law on tax withholding “tracks” the Internal Revenue Code and “is intended to replicate the effect of its counterpart in the federal code.” In re Nash Concrete Form Co., 159 B.R. 611, 615 (D. Mass. 1993).

So, it doesn’t matter to the employees that the employer failed to pay over the withheld taxes, but it does matter to employees that this withholding is documented.  They do not need to keep tabs on their employer or worry in any way about what happens to their money after it is withheld as long as they have the proper proof of withholding.

This system of giving employees credit for any amount withheld makes perfect sense and explains why normally employees do not think about the issue. Here, the shady method of making payroll and the apparent failure to send a year in statements puts these employees in an especially bad situation.

I am a bit troubled by the fact that the system also credits the responsible officers whose wages are withheld, but I guess that’s not a big enough concern for anyone to change the statute.  For anyone interested in my longer writings on the subject of trust fund taxes and what happens when the party holding the money in trust fails to pay it over, you can find my law review articles here, here and here.

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