How Factors Can Increase Sales by Resolving Payroll Tax Liability
Business development has become difficult enough in the COVID-19 environment without having to drop clients with potential payroll tax liability issues. Elizabeth Nelson walks through potential solutions so that factors can save and retain clients experiencing such difficulties.
BY ELIZABETH NELSON, ESQ.
The COVID-19 pandemic increased payroll tax delinquencies with resulting tax liens. Further, the IRS expects more delinquencies in 2021 than in 2020. Concurrently, factoring companies are facing challenges securing new clients. There are solutions for business development officers who want to help companies quickly resolve payroll tax liability and then convert those companies into clients. These solutions require a BDO to get more involved with companies to save or acquire new clients. This article discusses the pitfalls of payroll tax liability and resulting tax liens and provides strategies to settle them.
CONSEQUENCES OF FAILURE TO DEPOSIT, FILE AND PAY PAYROLL TAXES
Collection of payroll tax is vitally important to the functioning of the United States government. The IRS collects 95% to 96% of all the revenue for the United States. Payroll tax comprises 72% of tax collection. In 2019, payroll tax accounted for $1.2 trillion in revenue from 31.6 million filed returns. As a result, payroll tax delinquencies are the IRS’ highest enforcement priority, with increased unannounced revenue officer visits and asset seizures.
Companies that need factoring are usually subcontractors for industries such as construction, oil and gas, pipeline and transportation. When the contractor stops payments without cause, subcontractors are usually contractually required to finish a portion of the job, requiring continued payment of worker salaries. When that happens, any cash goes toward worker salaries and the payroll tax is not deposited and returns are not filed. This results in delinquent payroll tax liabilities, which are not the fault of the company.
The penalties and interest for late payroll tax deposits, late filing returns and late payment of payroll tax can total up to an additional 65% of the total tax due. In 2019, the IRS issued approximately 5 million civil penalties on employers who failed to pay employment taxes, with $13.7 billion in additional assessments.
Paying employment taxes is inevitable. A company withholds taxes from employee pay and, thus, has a fiduciary duty to transmit the money to the IRS. These taxes are called trust fund taxes and, by law, belong to the government.
A particularly severe penalty (the trust fund recovery penalty) applies to “responsible persons” of a company. Responsible persons are company officers, directors and/or anyone who makes decisions about how to pay employees or has check-signing authority. A civil penalty equal to the full amount of the unpaid trust fund tax, plus interest, can be assessed against the social security number of any responsible person. Hence, payroll tax becomes personal tax.
EXPLAINING TAX LIENS AND THE 45-DAY SAFE HARBOR RULE
A federal tax lien is the government’s legal claim against a company for failure to pay taxes. A federal tax lien is filed after the IRS assesses the tax liability and sends a bill that explains how much is due (Notice and Demand for Payment). The IRS files a federal tax lien after a company fails to pay the tax within a certain time. The IRS also files a Notice of Federal Tax lien within the county of the location of the client’s business.
Factor companies require the filing of a UCC-1 statement prior to funding a client. This UCC statement protects a factor company’s interest in the accounts receivable. What happens to the UCC statement when the IRS files a federal tax lien?
Ordinarily, pre-existing security interests, such as accounts receivable, lose priority to the federal tax lien. For accounts receivable, which come into existence after the lien is filed, the lien statute includes a statutory safe harbor, which allows a factor’s UCC to retain priority with respect to accounts receivable disbursements during the first 45 days following the filing of the federal tax lien. The IRS has priority on all accounts receivable and cash that come into existence commencing on the 46th day.
There is one exception to this safe harbor rule. The 45-day period is shortened to the date at which the factor has actual knowledge of such a lien filing. For example, if the factor has knowledge of the lien on the 25th day, the safe harbor is only 25 days. Thus, the IRS has priority of future advances made after the factor learns of the federal tax lien filing. The IRS has the burden of showing that the lender had actual knowledge of the tax lien filing. On the date that the factor discovers that a federal tax lien has been filed, all advances should cease until the federal tax lien is subordinated.
CONVERTING COMPANIES WITH PAYROLL TAX ISSUES INTO CLIENTS
Factor companies have different rules on settling tax liabilities prior to funding. Some require only an installment agreement, while others require both an installment agreement and an IRS lien subordination to the UCC statement if a lien was filed.
A successful factor BDO must be proactive in both assisting a company in securing factor services and stopping IRS collections. Experienced payroll tax professionals’ names and contact information must be provided to the company unless one is already working with the company. Believing that the company president can self-solve its IRS problems is not realistic. They will not. They cannot. The IRS is the largest collection agency in the U.S. and holds all the power and knowledge of the rules it requires. A business owner does not know the IRS rules, settlement options and pre-seizure time deadlines. They do not have access to the IRS attorney hotline. Failure to know IRS rules can cause a company to lose assets, leaving nothing left to factor.
For a BDO who has expended time securing a company as a client, especially in the COVID-19 business environment, time is of the essence, and a solution can be achieved within seven to approximately 30 days by working with a tax professional.
Obtain an IRS Power of Attorney (POA) from the tax professional to stop unexpected visits from the IRS collection revenue officer (RO). Why? Because the RO must contact the POA and ask permission before visiting the company. When the RO shows up unannounced, they are looking for assets to seize. Additionally, this protects against a potentially unaware company representative providing information that is not required.
The next step is for the tax professional to secure an installment agreement (IA) within seven to 30 days while simultaneously filing a lien subordination, which takes approximately 30 days. The BDO should quickly provide the factor company contract and UCC statement to the tax professional. It will be required for the lien subordination.
In my experience, with proper documentation of the factor contract, the IRS will subordinate the lien. Under IRC §6325(d)(2), the IRS will subordinate its tax lien with proof that collection of the tax liability will increase. The subordination will increase the collection of taxes because the factor company will continue payments of accounts receivable to the company so it will have funds to continue its business. The IRS does not want the company to go out of business.
Lastly, it is possible to mitigate IRS wrath for unpaid payroll tax. BDOs can work with the company and the tax professional to find proof of the following:
The company did not pay other bills during the time the IRS was not paid
The contractor illegally withheld funding or illegally cancelled the contract
Lawsuit information that will lead to full payment of the outstanding taxes and penalties
Embezzlement or theft
Delinquency was due to unforeseeable events, such as an illness, major accident or death of a partner, significant other or child
The BDO, company and tax professional also should review the numbers on the payroll tax forms that were filed for accuracy, and then perhaps conduct a forensic accounting. Provide these explanatory situations to the IRS RO when requesting both the IA and the lien subordination for improved IRS assistance in securing the requested relief.
While waiting for the lien subordination, the factor company can fund the IA by directly paying the IRS from the accounts receivable invoices. There are additional methods to successfully solve company payroll tax issues, but they are beyond the scope of this article.
If a BDO finds that a client or a prospective client owes payroll tax, it is possible to keep or sign the client. The specific solutions listed earlier in this article will enable a BDO to help a company navigate resolution for payroll tax liability by securing an IRS installment agreement and/or lien subordination. As factoring companies continue to face COVID-19 challenges, do not dismiss potential clients with payroll or other tax issues. Instead, seek the advice of a payroll tax professional to quickly resolve these tax issues to save or acquire new clients.