In a recent criminal prosecution of a medical doctor/entrepreneur for defrauding his company’s shareholders, the government employed a novel theory of securities fraud premised, in part, upon the defendant’s failure to pay federal employment taxes withheld from his employees’ wages. The government alleged that the defendant, Sreedhar Potarazu, an ophthalmic surgeon licensed in Maryland and Virginia, made repeated false statements to shareholders about the financial condition of VitalSpring Technologies Inc., a company he founded, including concealing the fact that the company failed to pay more than $7.5 million in federal employment taxes. Ensuring that companies are fully compliant with their employment tax obligations is one of the top priorities of the Justice Department and Internal Revenue Service, and this case stands as a rare example of the confluence of the federal securities and employment tax laws.

Potarazu served as the company’s chief executive officer and also served on its board of directors. The government alleged that from at least 2008, Potarazu provided materially false and misleading information to VitalSpring’s shareholders to induce more than $49 million in capital investments in the company. According to the government, Potarazu induced investments from shareholders by making false representations, concealing material facts, and telling deceptive half-truths about VitalSpring’s financial condition, tax compliance, and alleged imminent sale. Potarazu represented on numerous occasions that VitalSpring was a financially successful company and that a sale of VitalSpring was imminent, which would have resulted in profits for shareholders. Potarazu concealed from shareholders that VitalSpring failed to account for and pay over more than $7.5 million in employment taxes to the IRS. Potarazu provided false corporate income tax returns to some shareholders that overstated VitalSpring’s income and omitted the accruing employment tax liability. From 2011 to 2015, in addition to his salary paid by VitalSpring, Potarazu diverted at least $5 million from the investors and VitalSpring for his own personal use.

Between 2007 and 2016, VitalSpring accrued federal employment tax liabilities of more than $7.5 million. The company withheld taxes from VitalSpring employees’ wages, but failed to fully pay over the amounts withheld to the IRS. As chief executive officer, Potarazu was a “responsible person” obligated to collect, truthfully account for, and pay over VitalSpring’s employment taxes. According to the government, ultimate and final decision-making authority regarding VitalSpring’s business activities rested with Potarazu. Potarazu was aware of the employment tax liability as early as 2007 and between 2007 and 2016, was frequently apprised of VitalSpring’s employment tax responsibilities by his employees. In addition, IRS special agents interviewed Potarazu in 2011 and informed him of the employment tax liability. In all but one quarter between the first quarter of 2007 and the last quarter of 2011, as well as the second and third quarters of 2015, Potarazu failed to file VitalSpring’s Employer’s Quarterly Federal Tax Return (Forms 941) with the IRS. Potarazu also failed to pay over any of the employment tax withheld from VitalSpring’s employees’ wages in all but one quarter between the second quarter of 2007 and the third quarter of 2011, as well as the third and fourth quarters of 2015. Between 2008 and 2015, instead of paying over employment tax, Potarazu caused VitalSpring to make millions of dollars of expenditures, including thousands of dollars in transfers to himself and others, the publication of his book, a sedan car service, and travel.

Potarazu eventually pleaded guilty to one count of securities fraud and one count of failing to account for and pay over federal employment taxes. In his guilty plea, Potarazu acknowledged that he provided materially false and misleading information to his company’s shareholders to induce further capital investments, including concealing the fact that the company had accrued a multi-million dollar tax liability as a result of unpaid employment taxes. On July 19, Potarazu was sentenced to nearly ten years in prison, and ordered to pay $49.5 million in restitution to shareholders and $7.6 million to the Internal Revenue Service. He was also ordered to forfeit several homes, vehicles, and bank accounts.

Aggressive criminal and civil enforcement of the federal employment tax laws has been a top priority of both the Justice Department and the IRS for the past several years. Amounts withheld from employee wages represent nearly 70% of all revenue collected by the IRS. According to a recent report from the Treasury Inspector General for Tax Administration (TIGTA), as of December 2015, 1.4 million employers owed approximately $45.6 billion in unpaid employment taxes, interest, and penalties. The Justice Department’s Tax Division reports that as of June 30, 2016, more than $59.4 billion of taxes reported on quarterly federal employment tax returns remained unpaid. Employment tax violations represent more than $91 billion of the “Tax Gap,” which measures the difference between the total amount of tax owed to the U.S. Treasury and the amount actually paid. During fiscal year 2016, employment tax investigations were one of the few categories of tax crimes for which IRS-Criminal Investigation initiated more investigations than in the prior fiscal year.

Employment tax schemes can take a variety of forms. Some of the more common schemes include employee leasing, paying employees in cash, filing false employment tax returns, failing to file employment tax returns, and “pyramiding.” Pyramiding refers to the practice of withholding taxes from employee wages, but failing to remit such taxes to the IRS. After the employment tax liability accrues, the business owner starts a new business and begins to accrue employment tax liabilities anew.

In securities fraud cases, the government often charges that a company’s books and records are manipulated in order to falsely inflate revenue and earnings. For example, in United States v. Hyunjin Lerner (S.D. Fla. Mar. 29, 2017), the indictment alleged that the defendant and his co-conspirators engaged in a complex accounting fraud, utilizing unsupported expense accruals, improper accounting entries, misclassification of expense items, and false revenue items, in order to boost the company’s revenue and earnings. Similarly, in United States v. Joseph A. Kostelecky (N. Dakota Jan. 6, 2017), the defendant was charged with securities fraud in connection with an alleged scheme to artificially inflate his company’s revenue based upon the booking of revenue from oil and gas contracts, where such contracts did not exist or the revenue from such contracts was not collectible. In United States v. Brian Block (S.D.N.Y. Sept. 8, 2016), the indictment charged the chief financial officer of a publicly-traded real estate investment trust with securities fraud in connection with his alleged fraudulent inflation of a key metric used to evaluate a REIT’s financial performance in filings made with the Securities and Exchange Commission.

In securities fraud cases alleging materially false and misleading statements, it is rare for such statements to involve a company’s general tax compliance. Even more rare are cases involving false statements about a company’s employment tax compliance.  Indeed, the Potarazu case may be the first securities fraud case to allege that shareholders and investors were misled about a company’s employment tax compliance. With the intense focus now being paid to employment tax enforcement by the Justice Department and Internal Revenue Service, we may well see more cases, like Potarazu, where securities fraud schemes and employment tax fraud schemes are intertwined.

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2000px-Seal_of_the_United_States_Department_of_Justice_svgFollowing a relentless flurry of press releases announcing criminal charges against tax evaders in the run up to today’s tax filing deadline (see here, here, and here), the Justice Department wasted no time in turning its attention to its next target:  employers and individuals who violate the federal employment tax laws. In a press release entitled “Justice Department Continues To Sue, Prosecute Delinquent Employers,” the Justice Department emphasizes that it is continuing its employment tax “enforcement push” by bringing civil and criminal enforcement actions against employers and individuals who violate employment tax laws:

Many Americans associate April with “Tax Day” and the annual deadline for filing individual income tax returns. But the end of April is also the first deadline for employers to file quarterly employment tax returns. Those who do not comply with filing requirements or who fail to pay the taxes withheld from their employees’ wages face civil lawsuits or criminal prosecutions as part of the Department of Justice’s ongoing focus to enforce employment tax laws using all tools available.

By way of background, employers in the United States are required to collect, account for, and pay over to the Internal Revenue Service tax withheld from employee wages, including federal income tax and social security and Medicare taxes. Employers also have an independent responsibility to pay their matching share of social security and Medicare taxes.

“Employers who willfully fail to comply with their employment tax obligations are cheating the U.S. Treasury at the expense of taxpayers, such as law-abiding employers and employees, who pay their taxes on time and in full,” said Acting Assistant Attorney General David A. Hubbert of the Justice Department’s Tax Division. “The Department is committed to holding employers that willfully fail to pay their employment taxes accountable with, as appropriate, criminal prosecution, bringing these offenders into compliance through civil injunctions, and working with the IRS to collect what is owed.”

“Employment taxes are a critical part of the tax system, generating more than $1 trillion a year in payments to the government, and the IRS works closely with employers and the payroll community to help ensure compliance in this area,” said IRS Commissioner John Koskinen. “We want to help employers avoid problems in the employment tax area. When problems do arise, we use civil enforcement tools and, when appropriate, work closely with the Justice Department in the pursuit of criminal cases. The collection of employment taxes is a priority area for the IRS and helps ensure fairness for employers and taxpayers. Employers who fail to pay or withhold these taxes enjoy an unfair economic advantage over those who comply with the tax laws.”

The Justice Department’s press release serves as a reminder that an individual’s willful failure to comply with employment-tax obligations is not simply a civil matter. Employers whose business model is based on a continued failure to pay employment tax, who use withheld employment taxes as a slush fund to pay personal expenses or other creditors, who pay employees in cash to avoid employment tax obligations, or who file false employment tax returns can subject themselves to prosecution, imprisonment, monetary fines, and restitution.

Aggressive criminal and civil enforcement of the federal employment tax laws has been a top priority of both the Justice Department and the IRS for the past several years. Amounts withheld from employee wages represent nearly 70% of all revenue collected by the IRS. According to a recent report from the Treasury Inspector General for Tax Administration (TIGTA), as of December 2015, 1.4 million employers owed approximately $45.6 billion in unpaid employment taxes, interest, and penalties. The Justice Department’s Tax Division reports that as of June 30, 2016, more than $59.4 billion of taxes reported on quarterly federal employment tax returns remained unpaid. Employment tax violations represent more than $91 billion of the “Tax Gap,” which measures the difference between the total amount of tax owed to the U.S. Treasury and the amount actually paid. During fiscal year 2016, employment tax investigations were one of the few categories of tax crimes for which IRS-Criminal Investigation initiated more investigations than in the prior fiscal year.

Employment tax schemes can take a variety of forms. Some of the more common schemes include employee leasing, paying employees in cash, filing false employment tax returns, failing to file employment tax returns, and “pyramiding.” Pyramiding refers to the practice of withholding taxes from employee wages, but failing to remit such taxes to the IRS. After the employment tax liability accrues, the business owner starts a new business and begins to accrue employment tax liabilities anew.

Today’s press release highlights recent examples of employment tax enforcement in both the criminal and civil arenas, starting with the following examples of employers who engaged in “pyramiding” taxes by opening successive businesses:

In January, Napoleon Robinson of Lauderhill, Florida, was sentenced to serve 18 months in prison for evading more than $500,000 in employment taxes. Robinson owned and operated a series of ship welding and repair businesses in Virginia and New York. Robinson was not paying over employment taxes and would close down one company and open a new one in the name of a nominee owner, while continuing to run the company, making its financial and personnel decisions and controlling the businesses’ bank accounts. He was also ordered to pay restitution to the IRS.

In January, two West Virginia business owners, Michael and Jeanette Taylor, were sentenced to serve 21 and 27 months in prison for failing to pay over more than $1.4 million in employment taxes. The Taylors owned a construction business that transported steel and sold gravel and concrete. They changed the name of their business several times, though the operations of the business remained the same. Both were responsible for collecting, accounting for and paying over the employment taxes withheld from their employees’ wages. Instead of paying over the taxes that they collected, the Taylors used the funds to purchase property and finance their horse farm. They were also ordered to pay restitution to the IRS.

The following cases demonstrate examples of employers who used withheld employment taxes to pay personal expenses, or to pay other creditors:

In January, Paul Harvey Boone of Hillsborough, North Carolina, was sentenced to serve 15 months in prison for failing to pay over employment taxes. Boone owned and operated Boone Audio Inc. From 2008 through 2011, Boone used company funds for personal expenses while failing to pay over the employment taxes withheld from his employees’ wages. He was also ordered to pay restitution to the IRS.

In December 2016, Sreedar Potarazu, a Maryland surgeon and entrepreneur, pleaded guilty to failing to account for and pay over $7.5 million in employment taxes and to shareholder fraud. Potarazu founded VitalSpring Technologies Inc., a corporation that provided data analysis and services related to health care expenditures. Potarazu was responsible for collecting, truthfully accounting for and paying over VitalSpring’s employment taxes. Instead of paying over the employment tax, Potarazu spent millions on personal expenses including transferring funds to himself and others, travel, car service and the publication of a book.

In January, Steven Lynch, a tax attorney and owner of the Iceoplex in Pittsburgh, Pennsylvania, was sentenced to serve 48 months in prison, fined $75,000 and ordered to pay restitution to the IRS of more than $793,000, after being convicted of failing to collect, account for and pay over employment taxes. Lynch co-owned and operated the Iceoplex, a recreational sports facility which included a fitness center, ice rink, soccer court, restaurant and bar. He controlled the finances for these businesses and was responsible for collecting, accounting for and paying over tax withheld from employee wages and timely filing employment tax returns. Lynch failed to pay over more than $790,000 in employment taxes withheld.

In June 2016, Muzaffar Hussain of Pleasanton, California, pleaded guilty to failing to account for and pay over employment taxes for Crossroads Home Health Care Inc. Hussain was the CFO and was responsible for filing the company’s employment tax returns and paying over the employment taxes. Hussain transferred funds in an amount equal or close to the amount of employment taxes from the business bank account into other accounts and used the money to fund other business and personal expenses.

In the following case, the Justice Department prosecuted an employer who paid employees in cash to avoid paying employment taxes:

In September 2016, Phillip Hui of Sicklerville, New Jersey, was sentenced to serve 15 months in prison for conspiring to evade payroll taxes on cash wages paid to illegal immigrants employed at his dry cleaning business. Hui hired foreign nationals from Mexico and Guatemala who did not have legal status in the United States and paid them in cash. Their wages were not reported on the quarterly employment tax returns filed with the IRS. He was also ordered to pay restitution to the IRS.

Employers who file false employment tax returns are also subject to prosecution, as the following cases demonstrate:

In March, Richard Tatum, a Houston, Texas, business owner of an industrial staffing company, pleaded guilty to failing to pay more than $18 million in employment taxes. Tatum filed false employment tax returns that did not report the majority of his employees and did not pay over the taxes he withheld from his employees. Instead, he used the money for luxury travel and to make payments on his ranch.

In January, Janis Ann Edwards, an Oklahoma City, Oklahoma, business owner, pleaded guilty to evading more than $3.5 million in employment taxes. Edwards was the sole owner of Corporate Resource Management Inc. and a number of related companies that operated as professional employer organizations. Edwards directed her employees to alter quarterly employment tax returns to reflect less payroll tax liability than was actually owed.

The Justice Department’s Tax Division is also aggressively pursuing civil enforcement action against those who fail to meet their employment tax obligations. Since 2003, the Division has permanently enjoined more than one hundred employers and obtained tens of millions of dollars in money judgments. Civil injunctions are court orders requiring the employer and principal officers to timely deposit and pay employment taxes to the U.S. Treasury. These court orders also impose various other requirements and prohibitions, including the obligation to provide notice of each deposit to the IRS, as well as restrictions on opening and operating new businesses and transferring or dissipating assets.

In recent years, the Tax Division increased the number of civil actions brought against employers who violate employment tax laws. In 2016, the Tax Division obtained employment tax injunctions against 38 employers—more than double the number of injunctions obtained in 2015. The injunctions obtained in the past year include court orders against employers throughout the United States, such as a St. Louis concrete business, a Florida restaurant, an Iowa lawn care business and a Michigan custom kitchen company.

Since January 1, 2017, the Tax Division filed 17 suits, collectively seeking more than $10 million in unpaid employment taxes, against tax-delinquent medical-care providers who, despite IRS notices and efforts to collect, have been non-compliant for three or more quarters, despite persistent attempts by the IRS to remind them of their obligations and to collect the unpaid taxes.

These 17 suits collectively seek more than $10 million in unpaid employment taxes and are part of an ongoing effort by the Justice Department and the IRS focusing on employment tax compliance. Among these cases is a suit filed in federal court in Minnesota to enjoin Dawda Sowe and Nurse Staffing Solutions Health Care from failing to pay employment taxes and to obtain a $2 million judgment against the business for employment taxes the business allegedly failed to pay over an eight-year period. Also, this month the Tax Division filed suit in federal court in Texas to obtain a court order requiring Jeanna Smith to timely file employment and unemployment tax returns for her business and pay those taxes in full, amongst other requirements. In this suit, the government also seeks a judgment for unpaid employment taxes and alleges that Smith incorporated several home-health care businesses, such as Paris Senior Care Group Inc., which accumulated more than $1.3 million in unpaid employment taxes.

Finally, those who violate an injunction can be charged with civil and criminal contempt and face being shut down, paying compensation for the damage the contempt caused and incarceration of the principal corporate officers. For example, a federal court in Washington held Dr. James Hood and his wife, Karen Hood, in contempt of court for a consistent pattern of failing to meet their tax obligations. The court later ordered the two to close their dental care businesses, cease operating as employers, and barred them from opening any new businesses where the Hoods would serve as employers by June 8, 2017.

Any individual who is responsible for ensuring that employment taxes are collected, truthfully accounted for, and paid over to the IRS, and willfully fails to do so or willfully attempts to evade or defeat paying employment taxes may be subject to a civil penalty equal to the amount of the unpaid withholdings. This civil penalty, referred to as the Trust Fund Recovery Penalty (TFRP), may be imposed even if the individual uses the employment tax to pay other creditors or keep the business afloat. Individuals subject to these penalties include, but are not limited to, corporate officers, treasurers, managers, and, in some circumstances, bookkeepers. In fiscal year 2015, the IRS assessed the TFRP against approximately 27,000 responsible individuals.

Since January 2013, the Tax Division has obtained tens of millions of dollars in money judgments against individuals subject to these penalties. For example, in July 2016, a Florida jury found the CEO and owner of a professional employer organization personally liable for more than $4.2 million due to his failure to pay his company’s employment taxes. In addition, in December 2016, the U.S. Court of Federal Claims found that the CFO of an Internet-marketing platform was responsible for his company’s failure to pay its employment taxes and entered a judgment of more than $500,000 against him. And in April, a federal court found the co-manager of an architectural woodwork installation company personally liable for $1.9 million due to his failure to pay his company’s employment taxes.

In contrast to the Justice Department’s press release touting its successes in the employment tax field, a TIGTA report issued less than 30 days ago painted a considerably less rosy picture of the government’s efforts to ensure employment tax compliance. In a report entitled “A More Focused Strategy Is Needed to Effectively Address Employment Tax Crimes,” TIGTA concluded that the IRS needs a better strategy to enhance the effectiveness of the agency’s efforts to address, and punish, egregious employment tax violators:

Employment tax noncompliance is a serious crime. Employment taxes finance Federal Government operations plus Social Security and Medicare. When employers willfully fail to account for and deposit employment taxes, which they are holding in trust on behalf of the Federal Government, they are in effect stealing from the Government. As of December 2015, 1.4 million employers owed approximately $45.6 billion in unpaid employment taxes, interest, and penalties. The TFRP is a civil enforcement tool the Collection function can use to discourage employers from continuing egregious employment tax noncompliance and provides an additional source of collection for unpaid employment taxes. In FY 2015, the IRS assessed the TFRP against approximately 27,000 responsible persons – 38 percent fewer than just five years before as a result of diminished revenue officer resources. In contrast, the number of employers with egregious employment tax noncompliance (20 or more quarters of delinquent employment taxes) is steadily growing—more than tripling in a 17-year period. For some tax debtors, assessing the TFRP does not stop the abuse. Although the willful failure to remit employment taxes is a felony, there are fewer than 100 criminal convictions per year. In addition, since the number of actual convictions is so miniscule, in our opinion, there is likely little deterrent effect.

TIGTA recommended that the IRS should use data analytics to better target egregious employment tax noncompliance, including identification of high-dollar cases and individuals with multiple companies that are noncompliant. In addition, TIGTA recommended that the IRS Collection Division expand the criteria used to refer potentially criminal employment tax cases to IRS-CI to include any egregious cases (not only those where a firm indication of fraud is present).

Notwithstanding TIGTA’s recent criticism, it is readily apparent that employment tax enforcement is a top priority for both the Justice Department and the IRS.  With the massive amounts of unpaid employment taxes that remain outstanding, we can undoubtedly expect to see vigorous enforcement in this area, both criminal and civil, in the coming months and years.

 

With less than two weeks until the April 18 deadline for filing individual federal income tax returns, the Justice Department and Internal Revenue Service are issuing stern warnings to potential tax cheats. Today the U.S. Attorney for the Western District of North Carolina and the Special Agent in Charge of the IRS Charlotte Field Office issued a joint press release entitled “Federal Prosecutors Warn Potential Tax Cheats: Tax Crimes Result In Criminal Prosecution, Lengthy Prison Sentences, And Fines.” Their press release announced recent tax fraud prosecutions and sentencings, and is intended to “deliver a powerful warning to those who are thinking about breaking the law by committing tax crimes.”

“As tax filing season reaches its peak, we are putting would-be tax cheats on notice: My office will prosecute those who try to cheat the tax system at the expense of honest taxpayers who file their returns on time and pay the taxes they owe. Our tax system is built on voluntary compliance and tax criminals who do not pay their fair share increase the tax burden on law-abiding taxpayers,” said U.S. Attorney Jill Westmoreland Rose.

“The 2017 income tax filing season is soon coming to a close, however, special agents of the IRS – Criminal Investigation work year-round to combat criminal violations of the Internal Revenue Code and related financial crimes. Agents in the Charlotte Field Office have pursued, and will continue to pursue, those who prepare returns fraudulently, steal and misuse identities, and those who take extraordinary measures to conceal their income in an effort to evade their tax responsibility,” said Special Agent in Charge Thomas J. Holloman, III. “To build faith in our nation’s tax system, honest taxpayers need to be reassured that everyone is paying their fair share and we will work vigorously to pursue those who do not.”

The press release proceeds to highlight recent successes in prosecuting tax evaders and those who file false tax returns:

Matthew Moretz, 31, of Taylorsville, N.C., pleaded guilty to one count of filing a false tax return. From April 2010 to March 2011, Moretz collected unemployment income from the North Carolina Division of Employment. However, beginning in or about March 2010 and continuing through in or about 2013, Moretz was self-employed as the owner of MJM Recycling, a scrap metal business. From tax year 2010 through tax year 2013, Moretz earned additional personal income totaling approximately $529,622.44 that Moretz failed to report on his U.S. Individual Income Tax Returns Form 1040 filed with the IRS. As a result of the unreported taxable income, Moretz had additional tax due and owing of approximately $116,409.38 from 2010 to 2013. Moretz is currently awaiting sentencing.

Patrick Emanuel Sutherland, 48, of Charlotte, was convicted of filing false tax returns and obstructing a federal grand jury investigation. Court documents and trial evidence showed that, from at least 2007 to 2015, Sutherland was an actuary, and the owner and operator of numerous companies in the insurance and financial industries. Between 2007 and 2010, Sutherland engaged in an elaborate scheme to conceal a substantial amount of income, including filing false tax returns with the IRS which underreported business receipts and personal income of approximately $2 million in income received from an offshore bank account in Bermuda, as well as from domestic sources. Sutherland is currently awaiting sentencing.

Reuben T. DeHaan, 44, of Kings Mountain, N.C., was sentenced to 24 months in prison for tax evasion and possession of an unregistered firearm. DeHaan owned a holistic medicine business, which he operated out of his residence in Kings Mountain under the names Health Care Ministries International Inc. and Get Well Stay Well. During the years 2008 through 2014, DeHaan earned more than $2.7 million in gross receipts from his holistic medicine business, but failed to file income tax returns for those years and evaded approximately $678,000 in income taxes due and owing. DeHaan was also ordered to pay 567,665 in restitution to the IRS and $110,449 to the state of North Carolina.

Another area of focus for the Justice Department and IRS are unscrupulous return preparers and those who perpetrate stolen identity refund fraud:

Ramos, formerly of Lincolnton, N.C., was previously sentenced to 48 months in prison for her role in a false claims conspiracy. The conviction stemmed from Ramos’s role in a conspiracy to defraud the government by filing fraudulent tax returns seeking refunds totaling more than $5 million, by using stolen identity information of individuals in Puerto Rico. Ramos fled the United States and failed to report to federal prison after the sentencing. She is awaiting sentencing on charges of obstruction of justice and failure to report and faces additional jail time and fines.

Cara Michelle Banks, Carmichael Cornilus Hill, and Priscilla Lydia Turner conspired with Senita Dill and Ronald Jeremy Knowles, and others, to file false federal and state tax returns using stolen personal identifying information. From 2009 to 2012, this conspiracy defrauded the United States Treasury of over $3.5 million. Banks, Hill, Turner and others stole personal identifying information and then provided it to Dill to file the false returns in exchange for payment. Dill and Knowles used stolen personal information to file over 1,000 false tax returns. Court records show that Hill provided approximately 26 percent of the stolen identifications used to file the fraudulent returns. In 2016, Banks and Hill were sentenced to 70 months and 75 months in prison, respectively. In November 2016, Turner pleaded guilty to aggravated identity theft and is currently awaiting sentencing. Senita Dill was sentenced to 324 months and Knowles to 70 in prison for their roles in the conspiracy.

Finally, an area of recent intensity for the Justice Department and IRS is employment tax fraud:

Frank Alton Moody, II, 57, of Arden, the co-founder and former Chairman of the Board of CenterCede Services, Inc., a payroll services company, was ordered to serve 30 months in prison, two years in supervised release, and to pay $2,146,380.97 as restitution, for conspiring to steal over $2 million from client companies. Moody’s co-conspirators, Jerry Wayne Overcash and John Bernard Thigpen, were previously sentenced to 46 months and 21 months in prison, respectively. The three men used the more than $2 million they stole from client companies to fund their exorbitant salaries. Overcash and Thigpen were also ordered to jointly pay $1.3 million as restitution to the victim client companies.

The press release concludes with a reminder to taxpayers to exercise caution during tax season to protect themselves against a wide range of tax schemes ranging from identity theft to return preparer fraud. Illegal scams can lead to significant penalties and interest and possible criminal prosecution. IRS Criminal Investigation works closely with the Department of Justice to shutdown scams and to prosecute the criminals behind them. The IRS has issued its annual “Dirty Dozen” which lists common tax scams that taxpayers may encounter, particularly during filing season. Taxpayers are urged look out for, and to avoid, the following common schemes:

  • Phishing
  • Phone Scams
  • Identity Theft
  • Return Preparer Fraud
  • Fake Charities
  • Inflated Refund Claims
  • Excessive Claims for Business Credits
  • Falsely Padding Deductions on Returns
  • Falsifying Income To Claim Credits
  • Abusive Tax Shelters
  • Frivolous Tax Arguments
  • Offshore Tax Avoidance

As we have written previously, it is well-known that the IRS and Justice Department typically increase the frequency of their press releases announcing enforcement activity in the weeks leading up to the filing deadline. In fact, academic research confirms that these agencies issue a disproportionately large number of tax enforcement press releases as “Tax Day” approaches:

Every spring, the federal government appears to deliver an abundance of announcements that describe criminal convictions and civil injunctions involving taxpayers who have been accused of committing tax fraud. Commentators have occasionally suggested that the government announces a large number of tax enforcement actions in close proximity to a critical date in the tax compliance landscape: April 15, “Tax Day.” These claims previously were merely speculative, as they lacked any empirical support. This article fills the empirical void by seeking to answer a straightforward question: When does the government publicize tax enforcement? To conduct our study, we analyzed all 782 press releases issued by the U.S. Department of Justice Tax Division during the seven-year period of 2003 through 2009 in which the agency announced a civil or criminal tax enforcement action against a specific taxpayer identified by name. Our principal finding is that, during those years, the government issued a disproportionately large number of tax enforcement press releases during the weeks immediately prior to Tax Day compared to the rest of the year and that this difference is highly statistically significant. A convincing explanation for this finding is that government officials deliberately use tax enforcement publicity to influence individual taxpayers’ perceptions and knowledge of audit probability, tax penalties, and the government’s tax enforcement efficacy while taxpayers are preparing their annual individual tax returns.

Joshua D. Blank and Daniel Z. Levin, When Is Tax Enforcement Publicized?, 30 Virginia Tax Review 1 (2010).

As “Tax Day 2017” approaches, expect to see similar announcements intended to deter would-be tax cheats from filing false tax returns.

2000px-Seal_of_the_United_States_Department_of_Justice_svgEnsuring that employers collect and pay over to the Internal Revenue Service taxes withheld from their employees’ wages is one of the highest priorities of the Justice Department’s Tax Division. Unpaid employment taxes are a substantial problem for the U.S. government, as amounts withheld from employee wages represent nearly 70 percent of all revenue collected by the IRS. As of June 30, 2016, more than $59.4 billion of federal employment taxes remained unpaid, and employment tax violations represent more than $91 billion of the “Tax Gap,” which represents the difference between the amount of taxes owed to the U.S. Treasury and the amount actually collected. In this context, several recent criminal prosecutions demonstrate the perils businesses, and their officers, face if they fail to carry out their legal duty to remit employment taxes to the IRS.

Background

Employers have a legal responsibility to collect and pay over to the IRS taxes withheld from their employees’ wages. These employment taxes include withheld federal income tax, as well as the employees’ share of social security and Medicare taxes (collectively known as FICA taxes). Employers also have an independent responsibility to pay the employer’s share of FICA taxes. The IRS takes the position that when employers willfully fail to collect, account for, and deposit with the IRS employment tax due, they are stealing from their employees and ultimately, the U.S. Treasury. The IRS also contends that employers who willfully fail to comply with their obligations and unlawfully line their own pockets with amounts withheld are gaining an unfair advantage over their honest competitors.

The Justice Department’s Tax Division pursues civil litigation to enjoin employers who fail to comply with their employment tax obligations and to collect outstanding amounts assessed against entities and responsible persons. In the last two years, in an effort to send a clear message to delinquent employers who treat taxes withheld from employee wages as a personal slush fund or loan that can be put off or ignored entirely, the Justice Department filed 55 injunction complaints in federal courts across the country and obtained 47 permanent injunctions. These injunctions require the timely deposit of employment tax and filing of employment tax returns, prompt notice to the IRS after each deposit, and notice to the IRS if the employer begins operating a new business. In addition, the injunctions preclude employers from assigning property or making payments to other creditors until the company’s employment tax obligations are paid.

The Tax Division also investigations and prosecutes individuals and entities who willfully fail to comply with their employment tax responsibilities, as well as those who aid and assist them in failing to meet those responsibilities. According to former Principal Deputy Assistant Attorney General Caroline D. Ciraolo, “[t]he willful failure to comply with employment tax obligations is a crime – plain and simple. Stealing employee withholdings and failing to pay them over to the U.S. Treasury, gives dishonest employers an unfair advantage over their law-abiding competitors. The department will continue to work with the Internal Revenue Service to prosecute these offenders and level the playing field.”

Recent Employment Tax Criminal Cases

On January 26, 2017, two West Virginia business owners were sentenced to prison for failing to pay over employment taxes. Michael Taylor and his wife, Jeanette Taylor, were sentenced to serve 21 months and 27 months in prison, respectively. According to documents filed with the court, from 2000 through 2010, the Taylors owned and operated a construction business that transported steel and sold gravel and concrete throughout West Virginia and Kentucky. The Taylors changed the name of the business several times, though the operations of the business remained the same. From 1999 to 2004, the business was operated as Taylor Contracting & Taylor Ready-Mix LLC. In 2004, the name changed to Taylor Contracting/Taylor Ready-Mix LLC. In 2010, the name changed a third time to Bluegrass Aggregates. Both Michael Taylor and Jeanette Taylor were responsible for collecting, accounting for, and paying over to the IRS federal income taxes and social security and Medicare taxes that were withheld from the wages of their employees. From July 2007 through 2010, the Taylors withheld over $850,000 from their employees’ paychecks, but instead of paying over the withheld taxes to the IRS, the Taylors used the funds to purchase property and finance their horse farm. The Taylors also failed to pay over $490,000 in employment taxes for their prior business. The total tax loss for the Taylors’ conduct is $1.4 million. In addition to the term of prison imposed, Michael Taylor was ordered to pay $1,440,130 in restitution to the IRS. Jeanette Taylor was ordered to pay $766,273 jointly and severally with Michael Taylor to the IRS.

On January 12, 2017, a Pittsburgh tax attorney was sentenced to four years in prison for failing to remit employment taxes to the IRS. According to court documents and the evidence presented at trial, between 2004 and 2015, Steven Lynch co-owned and operated the Iceoplex at Southpointe, a recreational sports facility located in Washington County, Pennsylvania. Iceoplex included a fitness center, ice rink, soccer court, restaurant and bar. Lynch controlled the finances for these businesses and was responsible for collecting, accounting for, and paying over tax withheld from employee wages, and timely filing quarterly employment tax returns. The jury found that between 2012 through 2015, Lynch failed to timely pay over to the IRS more than $790,000 in taxes withheld from the wages of the employees for these businesses. In addition to the prison term sentence, the Court ordered Lunch to pay $793,145 in restitution to the IRS.

On December 15, 2016, an Iowa businessman was sentenced to 13 months in prison after pleading guilty to failing to pay employment taxes. Darrell Smith was the president and general partner of Energae, which was a minority investor in Permeate Refining LLC., an ethanol-production business in Hopkinton, Iowa. In his position at Energae, Smith had significant control over the finances of Permeate and was responsible for paying over to the IRS employment taxes on behalf of Permeate’s employees. From the first quarter of 2011 through the third quarter of 2012, Smith failed to pay over $502,863. After Smith discovered that a subordinate employee had made some payments to the IRS, Smith stopped that employee from making further payments.

On October 24, 2016, the owner of several Nevada landscaping and rock hauling businesses was sentenced to 10 months in prison for failure to pay over employment taxes. In addition, the company’s bookkeeper was sentenced to five years’ probation with three months home confinement for willful failure to file an employment tax return. According to documents filed with the court, Kyle Archie was the part owner of Reno Rock Inc., GKPA Inc., and D Rockeries Inc. Kyle Archie admitted that he was responsible for the day-to-day operations of the businesses and that from 2003 through 2009, he had a legal duty to collect, truthfully account for, and pay over employment taxes to the IRS. He further admitted that although he collected these taxes from his employees’ wages and held them in trust, he failed to pay them over to the IRS for the third quarter of 2008. Linda Archie, who is Kyle Archie’s mother, worked as the bookkeeper for Reno Rock Inc., GKPA Inc., and D. Rockeries Inc. and was responsible for maintaining the books and records of the companies and filing documents with various government agencies. She admitted that between 2003 and 2009, she failed to file employment tax returns on behalf of these businesses to account for the taxes that were withheld from the employees’ wages. The Court also ordered both Kyle and Linda Archie to pay restitution to the IRS in the amount of $1,235,528.

Conclusion

These criminal cases demonstrate the harsh consequences that employers face if they willfully fail to comply with their legal duty to collect and remit employment taxes. Such cases will not simply be addressed civilly by the IRS with back payment of taxes and penalties by the employer, but instead may be criminally prosecuted and with responsible corporate officers facing prison sentences. This is particularly the case if the withheld taxes are used to pay personal expenses of the business owners and/or to fund luxurious lifestyles. The Justice Department and IRS are especially focused on “pyramiding,” which refers to the common practice of repeatedly filing bankruptcy once a substantial employment tax liability has accrued and opening a new business entity so as to avoid the payment of employment taxes, as occurred in the Taylor case described above. And the “willfulness” legal standard is not particularly difficult for prosecutors to satisfy, as nearly all employers are aware of their obligation to remit taxes withheld from their employees’ paychecks. Employers must take special care to ensure that withheld employment taxes are property remitted to the IRS given the intense focus now being paid to this area by the Justice Department and IRS.