TIGTA: IRS Has Mixed Success With Enforcement of ‘Ghost Employers’

The IRS’ criminal investigation processes for identifying and examining a certain group of noncompliant employers are currently more effective than civil enforcement workflows, according to the Treasury Inspector General for Tax Administration (TIGTA). (Report Number 2024-300-019)

In a report dated April 12 and released Wednesday, TIGTA reviewed the IRS’ recent-year efforts to crack down on “ghost employers,” a term the agency uses to describe employers that furnish employees with Forms W-2, Wage and Tax Statement, but do not send them to the Social Security Administration. Ghost employers also do not file Forms 941, Quarterly Federal Tax Return, nor do they make federal tax deposits, which makes detecting noncompliance “difficult,” TIGTA said.

“Ghost Employers are a significant challenge for tax administration because their failure to make Federal tax deposits results in lost employment taxes and income tax revenue and increases the Tax Gap,” or the difference between taxes owed and taxes collected. Federal tax receipts from employment taxes and income tax withholding accounted for 65% ($3.18 trillion) of all tax receipts in fiscal year 2022.

Initial efforts to identify delinquent employers started in November 2017 with IRS Criminal Investigation’s Nationally Coordinated Investigations Unit (NCIU), which worked to match Forms W-2 reflected on Forms 1040, U.S. Individual Income Tax Return, with the Forms 941 database to find gaps. The NCIU also coordinated with Research, Applied Analytics, and Statistics (RAAS) and a third-party vendor to create an algorithm for employment tax noncompliance.

During the period June 2018-May 2023, 354 leads were turned over to CI field offices. By May 2 last year, 93 were adjudicated or were “in the pipeline for potential prosecution,” while 136 investigations were active and 125 were closed or discontinued. As of May 2023, individuals were prosecuted for a total $43.55 million in restitution. The average sentence was 15 months on top of an average 33 months of probation.

“However, the workload and labor time needed to develop these cases are significant,” TIGTA concluded. “The timeliness of these cases is critical to reducing the impact of future fraudulent employers.”

On the civil side, the RAAS function initiated the Ghost Employer Project using a modified version of the CI algorithm. RAAS presented to the Data and Analytics Innovation Lab in April 2020 that 162,000 potential ghost employers were identified with an estimated liability of $1.7 billion. Of that sample, 280 were randomly selected to be assigned to the Small Business/Self-Employed (SB/SE) and Tax Exempt and Government Entities (TE/GE) divisions to establish a compliance strategy for ghost employers. The project, facing hurdles caused by the COVID-19 pandemic, would end in May 2022 despite many cases still being worked on.

As part of TIGTA’s audit, the Treasury watchdog requested a status update. Of those 280 cases, 93 were not placed into a workstream and 20 were referred to CI. Although 32 cases were assigned to the TE/GE Division, none were worked on when it was determined that “the cases would not be productive examinations.” The remaining cases were split between SB/SE teams: Examination, Collection Abusive Tax Avoidance Transaction, and Case Creation Nonflier Identification Process.

In reviewing 35 cases handled by SB/SE Division, Field Collection, TIGTA found that “only seven” involved ghost employers, primarily because in many instances, the employer had already filed employment tax returns and incurred an employment tax balance. These taxpayers are not considered to be “flying under the radar.”

“Accordingly, taxpayers with an employment tax balance or a history of filing employment tax returns” are not considered ghost employers by definition, TIGTA clarified.

Overall, the one-off Ghost Employer Project saw “limited success” due to lack of effective monitoring and tracking. No performance measures were set and the different operating divisions showcased a “lack of coordination” that “hampered the project,” TIGTA reported.

After making three recommendations to the IRS on how to tighten up processes for accurately identifying ghost employers and properly keeping track of casework, TIGTA advised the use of civil fraud penalties to achieve compliance.

“Abusive transactions, frivolous returns, and other abusive taxpayers’ conduct … undermine the fairness and integrity of the Federal tax system and undercut voluntary compliance,” TIGTA argued. “It is important in these cases for examiners and their managers to consider the potential applicability of penalties, and to fully develop the facts to either support the application of the penalty or to demonstrate that penalties should not apply.”