In part because of the increased publicity, accountants should be aware of some of the repercussions that may result for violations of payroll tax and/or immigration laws. Accountants also should be familiar with the changes made to some of these laws as a result of the Social Security Domestic Employment Reform Act of 1994.

Payroll Tax Rules

Employer-Employee Relationship. Payroll taxes do not apply unless an employer-employee relationship exists. The IRS has determined that the amount of control retained by the purchaser of services is the main factor in deciding whether such a relationship exists - the greater the control, the more likely there is an employer-employee relationship. To aid in the evaluation of a particular situation, the IRS has published a list of 20 factors it uses to determine whether an employer-employee relationship exists. Some factors more likely to apply to domestic service situations are given in Exhibit 1. Care must be taken, however, when applying the list since the IRS weighs the factors differently depending upon the circumstances involved.

Types of Payroll Taxes. In general, employers are responsible for five types of payroll taxes. Two of these, Federal income taxes, and the employee's portion of Federal Insurance Contributions Act (FICA) taxes, must be withheld from the wages of an employee. The other three, which must be paid by the employer are 1) the employer's portion of FICA taxes, equal in amount to the employee's portion of FICA, 2) Federal Unemployment Tax Act (FUTA) taxes and 3) state and local unemployment insurance (SUI).

Of all of these taxes, domestic service employers have in the past had the most trouble complying with the rules concerning FICA taxes. For 1994 and later years, FICA taxes apply only if cash wages of $1,000 (adjusted for inflation) or more are paid to a domestic service employee in any year (FICA taxes do not apply to noncash fringe benefits). If FICA was paid in 1994 for a domestic worker that had cash wages of less than $1,000, a refund is allowed. To eliminate having to pay FICA with respect to wages paid to the neighborhood teenage baby sitter, FICA taxes do not apply to domestic employees under the age of 18 unless domestic service is the principal occupation of the employee.

FICA taxes are actually made up of two types of taxes: an Old Age, Survivors, and Disability Tax (OASDI) and a Hospital Insurance Tax (HI), also known as the Medicare tax. For 1995, both the employer and the employee must pay 6.2% of the first $61,200 (called the wage base) in employee wages in OASDI taxes and 1.45% on all wages in HI taxes. The wage base is adjusted annually for inflation, while the tax rates may be changed periodically by law.

While the employee pays a portion of the FICA taxes, the employer is responsible for withholding these taxes from the employee's wages. Some employers of part-time household help may find it easier, however, to pay both the employer's and the employee's portions of the FICA taxes rather than withholding amounts from the employee's paycheck. There is a special rule allowing employers to make such payments on behalf of their household workers without increasing the total amount of wages subject to FICA.

FUTA taxes do not apply unless cash wages of $1,000 or more have been paid to a household employee in any quarter of the current or prior year. If the employer meets the $1,000 threshold, then he or she must pay 6.2% of the first $7,000 of the total wages paid to an employee. Unfortunately, there is currently no FUTA exemption for teenagers that do occasional domestic work, unless the employee is a son or daughter under the age of 21.

Withholding Federal income taxes is not required of employers of household employees. Federal income taxes are only withheld from the wages of these employees when the employee requests they be withheld and the employer agrees. If such an agreement has been reached between the parties, the amount withheld should be determined by an officially approved method.

Filing Requirements. Before 1995, employers responsible for paying or withholding payroll taxes had to file a number of forms. However, the filing rules for employers of domestics have been greatly simplified. For 1995 and later years, the FICA, FUTA, and Federal income tax withholding obligations with respect to domestic employees can be reported with the employer's annual tax return (Form 1040). Any required FICA, FUTA, and Federal income tax withholding payments can also be made with the employer's annual return through 1997. For 1998 and later years, taxpayers must increase their withholding or estimated tax payments to cover the amount of any FICA, FUTA, and Federal income tax withholdings related to wages paid to domestic employees.

The above simplified filing rules do not apply to employers who are also liable for employment taxes on other, nondomestic types of employees. For example, sole proprietors of businesses that file Form 941, Employer's Quarterly Tax Return, should include household employees on that form instead of their own Form 1040. Under such circumstances, withheld taxes due of less than $500 a quarter should be remitted quarterly with the Form 941. If taxes accumulate to at least $500 during a quarter, they must be deposited with a Federal Reserve Banks or other authorized bank, along with a completed Federal Tax Deposit Coupon, Form 8109. The required payment dates will vary depending on the amount owed, but for most employers of domestics the due dates will coincide with the 15th day of the following month.

Employers must also send each employee a Form W-2, Wage and Tax Statement, by January 31 of each year, using the withholding allowance information provided by the employee on Form W-4, Employees' Withholding Allowance Certificate. In addition, a copy of the W-2 must also be sent to the Social Security Administration, along with Form W-3, Transmittal of Income and Tax Statements, by the last day of February. A checklist of the required filings is provided in Exhibit 2. Exhibit 2 only applies for employers not liable for any employment taxes on employees that are not domestics. The rules where a taxpayer employs either nondomestic employees alone or a combination of domestic and nondomestic employees are significantly different.

These payroll tax laws apply to all employers - whether the employer hires documented or undocumented workers. Additional information regarding the tax responsibilities of employers (including those hiring domestic service employees) is available in Circular E, Employer's Tax Guide, or Publication 926, Employment Taxes for Household Employers, both of which can be obtained from the IRS.

Because of the work involved in filing the correct forms (W-2, W-3, Form 1040) and paying the taxes owed, the idea of not complying with payroll tax laws for domestic service employees is often tempting. This is especially so since the employee is usually eager to maximize his or her take-home pay, and may therefore like the idea of no payroll tax deductions. It should be kept in mind that the same employee, sometimes years later, may wish to get credit from the Social Security Administration for time spent working as a domestic, whether FICA was withheld and paid in or not. If the employee seeks benefits based on those years of service, the nonpayment of the prior years' FICA taxes may be investigated by the IRS. At such a time, years after the fact, it will be the employer who is liable for the taxes (and penalties), not the employee.

Immigration Law

Under the Immigration Reform and Control Act of 1986 (IRCA), all employers must verify the identity and work authorization of new employees, including household employees, by obtaining certain documents from the job applicant. A list of these documents is provided in the Immigration and Naturalization Service's (INS) Handbook for Employers. The handbook details three types or groups of documents that 1) document both the identity and employment eligibility of an applicant (such as a U. S. Passport, Certificate of U. S. Citizenship, Certificate of Naturalization, Resident Alien Card, etc.); 2) document only the identity of a new employee (such as a state-issued driver's license, state-issued ID card, etc.); and 3) document only the employment eligibility of the applicant (such as a Social Security Card, birth certificate, etc.). To comply with IRCA, an employer must obtain either one item from the first group or one item from each of the other two groups.

The employer must attest that the proper documentation has been examined by filling out Form I-9, Employment Eligibility Verification Form, which can be obtained from the INS. The employer is then required to retain the completed Form I-9 for either three years after hire or one year after termination, whichever date comes later. No further validation of the documents is required, as long as they appear to be authentic. While an employer cannot reject documents that appear to be authentic, if that employer later discovers that false documents were presented by an unauthorized worker, he or she has an obligation to terminate the employee.

Penalties for Noncompliance With Payroll Tax Law

General Payroll Tax Penalties. The IRS assesses penalties against those who 1) fail to file their tax return, 2) fail to pay any tax they are found to owe, or 3) neglect to deposit withheld taxes on a timely basis. The penalty for failure to file a tax return is 5% of the tax owed per month, up to a maximum of 25%. The penalty for not filing a return within 60 days of the due date is the lesser of $100 or the amount of tax which should have been shown on the return. The penalty for the failure of an employer to pay the tax they owe is 0.5% of the tax due per month (1% after notice by the IRS), up to a maximum of 25%. If the employer is guilty of both failing to file a return and failing to pay the tax they owe, the maximum penalty is 5% of the tax due per month, up to a maximum of 25%. Depending upon the length of time the payment is overdue, penalties for the late deposit of withheld taxes range from 2% to 15%.

The failure to pay payroll taxes may also be a criminal offense in certain circumstances. The willful failure to collect, account for, and remit any tax, by any person who is required to do so, is a felony punishable by a fine of not more than $10,000, imprisonment for not more than five years, or both. Willful failure to file a return is a misdemeanor, punishable by a fine of not more than $25,000, imprisonment for not more than one year, or both.

One Hundred Percent Payroll Tax Penalty. In addition to the penalties previously mentioned, IRC Sec. 6672 imposes a 100% penalty on any "responsible person" who fails to remit taxes that have been withheld, or should have been withheld, from the paychecks of employees. These are called "trust fund taxes" and consist of the employee's share of FICA and Federal income taxes. The IRS views the failure to remit this type of tax as a form of embezzlement. As a maker of policy, the IRS generally attempts to collect unpaid trust fund taxes from "the employer" before seeking the funds elsewhere. The employer, however, is not determined to be any one particular person and a number of persons may meet the definition of an employer.

To hold an individual liable for these taxes, the IRS must identify a responsible person who has acted willfully and who has violated the requirements set forth under IRC Sec. 6672. This section provides that any person who is required to collect, account for, and pay trust fund taxes over to the IRS, but who has failed to do so, is subject to the 100% payroll tax penalty. Although the statutory language uses the conjunction "and" to connect the three requirements, the Supreme Court has ruled a person need not be required to have performed all three of the above functions to be held liable under IRC See. 6672. The Court reasoned that such an interpretation would not be logical because it would allow the penalty to be easily evaded through the manipulation of the parties' responsibilities. In actuality, any employer who has failed to remit income and social security taxes for his or her employees can be held liable for these trust fund taxes. This means employers of domestic employees (such as maids, baby sitters, and gardeners) can also be held liable for the applicable taxes should they fail to comply with payroll tax withholding requirements.

Immigration Law penalties

Like the penalties for payroll tax noncompliance, the penalties for noncompliance with immigration laws can be severe. Employers who knowingly hire undocumented aliens are subject to both criminal and civil penalties under IRCA. Civil penalties range from $250 to $2,000 per undocumented alien employee for the first offense, from $2,000 to $5,000 for the second offense, and from $3,000 to $10,000 for later offenses. In addition, if a "pattern of practice" can be proven, criminal penalties of up to $3,000 per unauthorized alien employee and up to six months imprisonment may be assessed.

Additional Consequences for Tax Accountants

Not only can a tax accountant who neglects to pay payroll taxes be liable for penalties, but tax practitioners that have authority to practice before the IRS can, under certain circumstances, have their authority revoked or suspended for serious tax law violations. In this regard, disbarment or suspension can result if the accountant 1) is convicted of a criminal offense under the U.S. revenue laws, or of an offense involving dishonesty, or breach of trust; 2) has been found to have willfully failed to file a Federal tax return in violation of U.S. revenue laws, or evaded a Federal tax; 3) has been disbarred or suspended from practice as an attorney or CPA; or 4) has knowingly aided and abetted another person to practice before the IRS while the other person is suspended or disbarred.

The circumstances under which the first three violations occur are fairly straightforward, while the last violation would seem to occur only in very limited circumstances. Under Treasury Circular 230, however, "aiding and abetting another person to practice" is presumed TABULAR DATA FOR EXHIBIT 2 OMITTED to occur if an accountant maintains a partnership for the practice of law, accountancy, or other related profession with a person who has himself been disbarred or suspended. In the extreme, this rule could result in the disbarment or suspension (from practice before the IRS) of an unknowing and innocent individual. Suppose one partner in a partnership has been totally honest and conscientious with respect to compliance with the payroll taxes. Another partner, however, has violated the rules and becomes disbarred or suspended from practice before the IRS. In this case, the complying partner may also face disbarment or suspension proceedings because the IRS presumes one partner is aiding and abetting the other partner. Although Circular 230 is silent on what proof is needed to rebut this presumption, it seems likely the presumption could be overcome by showing the complying partner did not help the other partner or his or her clients in dealings with the IRS.

Further Consequences for CPAs

The CPA who neglects to pay taxes on his or her own employees may face other consequences - the loss of the CPA license and membership in the AICPA and his or her state CPA society. In Texas, for example, according to the Public Accountancy Act of 1991, the penalties for "knowingly participating in the preparation of a false or misleading financial statement or tax return" range from a reprimand or censure of the licensee to a revocation of license. In addition, in Texas a conviction for a felony offense or a conviction for a criminal offense involving dishonesty or fraud can result in the revocation of the CPA license. Although most states' rules of conduct for CPAs are similar, the specific rules governing the sanctions for noncompliance with tax rules and financial standards should be obtained from the particular state board or other licensing agency.

The AICPA Code of Professional Conduct also contains provisions under which the membership of those violating payroll tax provisions can be terminated. According to this code, a member is subject to suspension or termination without a hearing if convicted of 1) preparing or filing a fraudulent income tax return; 2) willful failure to file a return (either his or her own individual income tax return or the return of a client); or 3) a crime punishable by imprisonment of more than one year. In addition, membership will be suspended if the member's CPA license or permit to practice is suspended, and membership will be terminated if the member's CPA license or permit to practice is revoked, withdrawn, or canceled.

RELATED ARTICLE: EXHIBIT 1 CHARACTERISTICS USED TO DISTINGUISH EMPLOYEES FROM INDEPENDENT CONTRACTORS

Characteristics of an employer-employee relationship:

1. The service purchaser has the right to require compliance with respect to when, where, and how the worker does the work.

2. Wages are paid by the hour, week, or month.

3. The service purchaser has the right to set the worker's hours or to fire the worker.

4. The service purchaser provides significant tools and materials for the job.

Characteristics of an independent contractor:

1. The worker offers similar services to the public.

2. The worker can realize a profit or loss.

3. The work is not performed on the premises of the service purchaser.

Cindy Seipel, PhD, CPA, and Larry Tunnell, PhD, CPA, are assistant professors at New Mexico State University.

Raymond A. Zimmerman, PhD, JD, is an assistant professor at the University of Texas at El Paso.