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Is Your Business Engaged in the Four Main Employment Tax Fraud Schemes Targetted by the IRS?

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Is Your Business Engaged in the Four Main Employment Tax Fraud Schemes Targetted by the IRS?


Most owners of companies and small businesses have, at least one, faced the temptation of under-reporting income, over-reporting expenses, and various tax schemes that can boost the company’s profits in the short-term. In other circumstances, playing “fast and loose” with an entity’s finances may be motivated by a downturn in business and a manager or owner’s desire to protect jobs. However, regardless of the factors that motivate the employment tax fraud, consequences are severe. For the failure to satisfy federal payroll tax obligations, penalties can include an imposition of personal liability on “responsible parties” like business owners or bookkeepers. In many cases where the audit is not properly managed, an employment tax fraud audit is fatal to the business.

How Does the IRS Detect Employment Tax Fraud?

The IRS utilizes an array of computer systems and other methods to assess a taxpayer’s likelihood of fraud. One of these tools is known as Combined Annual Wage Reporting (CAWR). CAWR is a program that compares the tax documents submitted by employers to the IRS and Social Security Administration. When documents submitted by the employer to these agencies do not match, there is a high likelihood that the red flags will trigger an audit.

Employment Tax Fraud Scheme #1: Paying Cash Wages

One of the most common and straightforward methods business owners use to commit employment tax fraud is the excessive use of cash including paying employee wages in cash. Some business owners mistakenly believe that the use of cash will protect them from employment tax suspicions. However, the IRS is well aware that cash presents a greater potential for abuse and have developed specific audit policies to uncover employment tax fraud through these means.

Employment Tax Fraud Scheme #2: Employee Leasing Companies

Employee leasing companies are a scheme by which a supposed third-party company hires some or all of a client companies employees. The alleged third-party company then leases the employees back to the client company or corporation. The next step in this scheme is the third-party company will generally fail to pay some or all of its employment tax obligations. If the facts and circumstances suggest that this third-party company was established to avoid or defeat the assessment or payment of tax, referral to IRS Criminal Investigations for criminal tax charges is possible.

Employment Tax Fraud Scheme #3: Pyramiding

Pyramiding is a defined fraudulent practice intended to improperly avoid the payment of employment taxes. The company will generally withhold employment and payroll taxes as it is required. However, after collecting and holding these funds, the entity fails to remit payment to the IRS. Over time, the unpaid quarterly taxes accumulate, or pyramid. Pyramiding businesses frequently shut down due to the ever-growing tax debt and then reincarnate as a thinly capitalized business. Often, the cycle begins anew at this point due to the company’s lack of capital.

Employment Tax Fraud Scheme #4: Payments Nonexistent Subcontractors and Entities

One final common method of employment tax fraud involves a taxpayer making claims for payments to nonexistent subcontractors. In some instance, no business may exist. In more sophisticated attempts at this scheme, the taxpayer may form multiple shell entities that exist only on paper and only for the purposes of reducing the business’s taxable income.

In many instances, local check cashing businesses are utilized in schemes of this type. Essentially the taxpayer will issue checks allegedly for payment for goods and services received. In reality, the entity did not provide any services or goods. The shell entity will cash the check at a local check-cashing business where for a fee or percentage of the check, the check is converted to cash. Some of the cash may be used for business expenses such as paying employee wages. And thus, this scheme and excessive cash dealings are often interconnected. Alternatively or additionally, the business owner or responsible party may keep the cash and fail to report it on his or her personal tax return.

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Concerned About Employment Tax Fraud Charges?

The above covers only four common employment tax schemes. The IRS is aware of many other methods of employment tax fraud including the mis-classification of employees as subcontractors, self-employed, or casual labor.

If your business has been contacted by the IRS or California Employment Development Division regarding unpaid employment taxes, the attorneys of the Tax Law Offices of David W. Klasing may be able to fight for you. Our tax professionals can set ground rules for an audit and work to mitigate the potential penalties you and your business face. To schedule a confidential reduced-rate employment tax consultation, call 800-681-1295. We have offices conveniently located in Orange County and Los Angeles.

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