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Business Tax

Taxpayer was the employer; professional employer organization didn’t control payment of wages

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

In Chief Counsel Advice (CCA), IRS has held that, where a taxpayer contracted with a professional employer organization (PEO) to, among things, remit the taxpayer’s employment taxes, and the PEO failed to remit those taxes, taxpayer was liable for the taxes. The CCA rejected taxpayer’s arguments that Code Sec. 3401(d)(1), which provides that a common law employer isn’t an employer for Federal income tax withholding purposes if he doesn’t control the payment of wages, and Section 530 of the Revenue Act of ’78, provided him relief from that liability.

Background. Under Code Sec. 3401(d)(1), if a common law employer does not have control of the payment of wages, the term “employer” means the person having control of the payment of wages. Although the Code imposes only Federal income tax withholding obligations on the Code Sec. 3401(d)(1) employer, case law has extended such an employer’s obligations to include withholding and payment of FICA and FUTA taxes. See, e.g., Otte, (S Ct 1974) 34 AFTR 2d 74-6194. The key issue in determining whether a taxpayer is a Code Sec. 3401(d)(1) employer of employees leased to a client company is to establish whether the taxpayer was in control of the payment of wages to those employees.

RIA observation: The Tax Increase Prevention Act of 2014 (TIPA) enacted a rule that a “certified professional employer organization” (certified PEO), and no other person, is to be treated as the employer liable for employment taxes with respect to wages paid by the certified PEO to a work site employee performing services for any customer of the certified PEO. TIPA required IRS to establish a certification program by July 1, 2015, which was to have been effective for wages paid on or after Jan. 1, 2016. IRS needed additional time to set it up and delayed the date that it would begin accepting applications for PEO certification until July 1, 2016. The PEO in this CCA was not a certified PEO.
Section 530 of the Revenue Act of ’78 (Section 530), as amended, provides that a taxpayer that incorrectly treats an employee as an independent contractor is nevertheless exempt from employment tax liability if it meets three requirements:

A. the taxpayer does not treat any other individual holding a substantially similar position as an employee for purposes of employment taxes for any period;
B. the taxpayer has consistently treated the worker as not being an employee for post-’78 periods, including by filing all required federal tax returns on a basis consistent with this treatment; and
C. the taxpayer has a reasonable basis for not treating the individual as an employee.
If all three Section 530 requirements are met, then for purposes of applying employment taxes for a particular tax period with respect to a taxpayer, “the individual shall be deemed not to be an employee.” If the worker is deemed not to be an employee, then the taxpayer has no employment tax liability with respect to remuneration paid to that worker for that period.

Facts. Taxpayer did not claim any deductions for officer compensation or salaries and wages on its tax return. Instead, Taxpayer claimed deductions for “Employee Leasing” for its entire workforce.

Prior to the years in issue, Taxpayer entered into a contract with a PEO. Under the contract: 1) Taxpayer assumes the responsibility for the day-to-day supervision and control of the individuals who the PEO retains to work at Taxpayer’s location, and the PEO does not have any liability, obligation or responsibility therefor; 2) Taxpayer must pay, at least one business day before each payroll date, an amount equal to all wages, salaries and any all other charges or payments to be paid to or with respect to the individuals who the PEO retains to work at Taxpayer’s location; 3) Taxpayer must provide a security deposit or procure a letter of credit naming PEO beneficiary in the amount as determined by the PEO to cover wages, salaries, contributions, premiums and any and all other charges or payments to be paid to or with respect to the individuals who the PEO retains to work at Taxpayer’s location; and 4) PEO may terminate the contract, immediately without notice, upon the occurrence of the Taxpayer’s failure to pay any invoice in full in the amount and at the time specified when due or any breach or default of the contract by Taxpayer. The contract provides that, in the event of termination for any reason, Taxpayer is responsible for payment of all wages, salaries and employment related taxes.

The duties of the PEO under the contract include: 1) administering Taxpayer payroll, designated benefits, and personnel policies and procedures related to the individuals who the PEO retains to work at Taxpayer’s location; and 2) remitting employment taxes and filing all employment tax returns with IRS and furnishing information returns to the individuals who the PEO retains to work at Taxpayer’s location.

Taxpayer learned on audit that the PEO failed to remit applicable employment taxes to IRS and asserted that it paid the amount in question in full to the PEO and is not liable for the unpaid employment taxes that the PEO failed to remit to IRS.

The PEO isn’t a Code Sec. 3401(d)(1) employer. IRS concluded that the PEO is not a “statutory employer” under Code Sec. 3401(d)(1) and that Taxpayer is not relieved of the employment taxes at issue.

IRS noted that several cases have dealt with the issue of what constitutes “control of the payment of wages” for purposes of determining if a taxpayer is a Code Sec. 3401(d)(1) employer.

In Winstead (CA 4 1997) 79 AFTR 2d 97-1977, the taxpayer owned land that was farmed by sharecroppers, who were accountable for their hired help. However, the sharecroppers could not pay the hired help until after the crops were sold. Therefore, the taxpayer paid the help from his checking account, over which the sharecroppers had no authority, then deducted what he paid from the sharecroppers’ share of the crop proceeds. The taxpayer was held to have control of the payment of wages to the hired help and thus to be the employer under Code Sec. 3401(d)(1).

Conversely, in In re Earthmovers Inc, (Bktcy Ct FL 1996) 78 AFTR 2d 96-6300, the taxpayer, Earthmovers, contracted with an employee leasing company, Sunshine. Pursuant to the terms of the contract, the employees were under the direction and control of Earthmovers, but Sunshine was responsible for the payment of wages to the employees, the collection of the appropriate payroll taxes from the paychecks, the payment of all employee withholding taxes due, and the filing of all necessary Federal tax forms. The court found that because Earthmovers submitted the information regarding the hours worked each week by each employee, forwarded the amount owed for payroll (including the tax amounts) to Sunshine, and retained the right to hire and fire the employees, Sunshine was not in control of the payment of wages for purposes of Code Sec. 3401(d)(1).

And, IRS noted other cases that have held a taxpayer to not be a Code Sec. 3401(d)(1) employer if the taxpayer received payroll information and funds from its client prior to the delivery of payroll to the client employees.

IRS concluded that, based on the provisions contained in the contract, the PEO is not considered to be in control of the payment of wages within the meaning of Code Sec. 3401(d)(1) because the PEO did not assume legal responsibility for payment of the wages to the employees. Under the terms of the contract, Taxpayer must pay the PEO an amount equal to the wages and salaries with respect to the workers in advance of the next payroll date. To ensure that the PEO will not be responsible for payment of wages to these workers, Taxpayer must provide a security deposit or letter of credit naming the PEO as beneficiary in the amount as determined by the PEO to cover the wages and salaries. Additionally, the PEO may terminate the contract immediately without notice, with Taxpayer being “responsible for payment of all wages, salaries and employment related taxes.”

Thus, IRS said, the PEO acted merely as a conduit for Taxpayer in making payroll and does not meet the standards in Code Sec. 3401(d)(1).

And Section 530 provides no relief to Taxpayer. IRS also concluded that Taxpayer is not entitled to relief under Section 530 because Section 530 is not applicable to the present dispute.

Section 530(a) focuses on the taxpayer’s treatment of the worker as an employee and not the taxpayer’s treatment of certain payments or services, the taxpayer’s payment of its liability, or the determination of which party is liable for employment taxes on payments made to the taxpayer’s employees. Congressional intent that Section 530 apply only to employee or nonemployee status determinations is reflected in the language found in Section 530(a)(1)(A) that the taxpayer “did not treat an individual as an employee for purposes of employment taxes.”

Similarly, the legislative history of Section 530 shows that Congress was providing a relief provision limited to controversies regarding whether a worker was or was not an employee of a service recipient. It explains that, in the late 1960s, IRS increased its enforcement of the employment tax laws, causing significant controversies between taxpayers and IRS about whether individuals treated as independent contractors should be reclassified as employees. Until Congress had adequate time to study the matter, it provided relief for taxpayers who were involved in controversies with IRS “involving whether certain individuals are employees for purposes of the employment taxes.” (Joint Committee on Taxation Staff, General Explanation of the Revenue Act of 1978, 95 Cong., at 301 (1979))

IRS said that, in the current fact pattern, there is no question regarding the proper classification status of the workers as Taxpayer’s employees. In fact, the contractual arrangement between Taxpayer and the PEO is predicated upon the treatment of Taxpayer’s workers as Taxpayer’s employees for employment tax purposes. Specifically, under the terms of the contractual agreement Taxpayer entered into with the PEO, Taxpayer was required to remit an amount equal to the wages paid to employees, along with the employer’s share of FICA and the requisite amount of FUTA taxes prior to the end of the payroll period, so that the PEO could meet the payroll requirements and pay the workers while withholding the corresponding amount of employment taxes.

Although Taxpayer did not directly pay the wages to its employees, withhold taxes from the wages paid to its employees or file Federal employment and information returns, Taxpayer specifically contracted with a third party for purposes of fulfilling these obligations with respect to the treatment of the workers as its employees. Thus, the contractual arrangement, in and of itself, demonstrates that no underlying issue of employment tax classification status exists regarding those who received wage payments. Rather, the dispute is limited to whether Taxpayer, as the common law employer, remains ultimately liable for the unpaid employment taxes at issue. As such, Section 530 is not applicable.

References: For who is a Code Sec. 3401(d)(1) employer, see FTC 2d/FIN ¶ H-4229; United States Tax Reporter ¶ 34,014.60. For Section 530 relief, see FTC 2d/FIN ¶ H-4300; United States Tax Reporter ¶ 34,014.37.

Chief Counsel Advice 201724025

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