A recent ruling from the IRS should serve as a warning to employers that hire professional employer organizations ("PEO") to manage payroll: the employer may still be liable for any failures to report and pay over employment taxes. Whether entering into third-party PEO arrangements or establishing their own entities to consolidate payroll functions, employers should have a clear understanding of their reporting and filing obligations with respect to employment taxes.
Recent Ruling
In LAFA 20171201F (Legal Advice Issued by Field Attorneys) released on March 24, 2017, the IRS held that an employer was liable for employment taxes that the employer's PEO failed to remit.1 The employer entered into a leasing arrangement with a PEO. Under the contract with the PEO, the PEO retained the employees to work at the employer's location. The contract designated the employees as "Co-Employees" of the employer and the PEO but stated that the employer was responsible for the day-to-day supervision and control of the employees. The PEO was responsible under the contract for administering payroll, furnishing and maintaining workers' compensation insurance covering the employees, and paying wages to the employees from the PEO's own account based on the hours reported by the employer. The arrangement required the employer to pay over to the PEO the wages and taxes owed before each payroll date.
The employer admitted that it was the common law employer because it demonstrated control over the employees but argued that the PEO was a "statutory employer" with control over the wages and responsible for properly remitting employment taxes. Under Section 3401(d) of the Internal Revenue Code, when the common law employer does not have control over the payment of wages, the "employer" responsible for employment taxes is instead the person having control over the payment of wages.2 That was not the end of the story, however. The IRS responded that case law concerning what constitutes "control over the payment of wages" rarely has held that a PEO has such control. In arrangements such as the one presented, where the employer first pays over to the PEO the wages and taxes owed, the employer is treated as having control over the payment of wages and is, therefore, responsible for employment taxes.3
Employer Liability
Common law employers are responsible for submitting employment tax returns and remitting employment taxes to the IRS. The IRS recognizes the need for some employers to outsource these responsibilities. As a result, certain arrangements permit common law employers to shift some of the responsibilities. However, under these arrangements, the common law employer must shoulder the liability for any failures. For example, an employer may use a Reporting Agent to submit employment tax returns and to remit taxes.4 Nevertheless, the employer, not the Reporting Agent, remains liable for failure to file and pay. With respect to PEOs, only where the PEO is treated as the true common law employer-which is based on the level of control over the employees-will the PEO be held liable for these failures. Employers using PEOs should be sure to fulfill their obligations with respect to employment taxes.
1 LAFA 20171201F is available at www.irs.gov/pub/irs-lafa/20171201f.pdf.
2 Although Section 3401(d) imposes federal income tax withholding obligations upon an employer, case law has extended such an employer's obligations to include withholding and payment of FICA and FUTA. See, e.g., Otte v. United States, 419 U.S. 43 (1974); In re Armadillo Corp., 561 F.2d 1382 (10th Cir. 1977).
3 See, e.g., Winstead v. United States, 109 F.3d 989 (4th Cir. 1997); In re Professional Security Services, Inc., 162 B.R. 901 (Bankr. M.D. Fla. 1993).
4 A Reporting Agent is an accounting service, bank, or other person that complies with Revenue Procedure 2012-32 and is authorized to prepare and sign employment tax returns electronically on behalf of a taxpayer and to make the required employment tax deposits. The Reporting Agent generally must complete IRS Form 8655 and enter into an agency agreement with the employer-taxpayer.
