Ep. 22 – How a Simple Payroll Mistake Led to a Criminal Investigation

Jamie Gruol: Welcome back to this episode of Diary of a Tax Practice Owner. I am one of your co hosts here on this podcast, Jamie Gruol, and I have with me.

Jessica Smith: Jessica Smith.

Jamie Gruol: Hey, hey.

Jessica Smith: Okay. Okay.

Jamie Gruol: of Jessica’s juicy stories about things that she has experienced in her past, in her career as a tax expert. And she has shared some doozies.

Today’s is not as juicy maybe as the others, but it is definitely scandalous. And it is something for you to think about when you’re, you know, we’re sharing these stories because we want you to just be exposed to. Some of the bigger things that can go on and when you, when you think something’s happening, like what do you do?

Where, where do you go? So Jess, today is going to be one of those days. So tell us what we’re going to be talking about today and which client you’re going to be spilling the tea on. And

Jessica Smith: we’re going to spill the tea on a taxpayer who had what just seemed to be a run of the mill, like employee misclassification situation, that actually turned into a larger issue when there was a suspicion that the taxpayer’s father was Part of an organized crime scenario.

Jamie Gruol: I want to hear this because how do you even find that out? Like those are usually on the DL and like, you know, how did you like, what was the journey on this one?

Jessica Smith: So I think, I think the most interesting thing about working for a law firm that did regularly deal with like criminal type activity, you know, when, when I first started there, I think I was like a little naive on like how often bad things happen and then you just kind of like get thrown into it and you’re like, Oh, it happens all the time.

So, so really with, with this particular taxpayer. He ran a service type business. And the, the, the way that he kind of got caught, right? So the business was owned by a husband and wife and it was the son and his wife, and then the father we think was actually the one running the business.

But his, for whatever reason, I, he was not able to be, or he preferred to not be the owner of record. And so his son and his wife were the owner of record and like ran the business. And I’m using air quotes for the people who are on who are listening. So, so with that, right. And, and this is not an unusual situation.

A lot of the times, if there are reasons why a specific taxpayer is prohibited from, let’s say, opening a bank account, or maybe they don’t have a clean criminal history and they’re not able to get licenses to perform certain things. Like, this happens all the time. I don’t think that this is overly unique where you have maybe people who are the owner on paper, but definitely not the owner when it comes to like the operating of the business.

So, so that didn’t seem too off when we first took on this taxpayer. And so they really got busted because, and mind you, there are millions of ways that the IRS picks up different cases to review, but this particular person was running a service based business. It was very, It had a lot of gross income.

So the more income you earn the more likely you are to come under scrutiny depending on a couple of different factors. And the difficult thing was the type of business this person ran, which I think was like in the automotive industry, if I have, if my memory serves me correctly, but there was no payroll and you IRS has said in many, On many situations.

And this isn’t like a one size fits all, but there are certain businesses that you just cannot run with like in truly independent contractors and get air quotes here for independent contractors.

Jamie Gruol: Yeah.

Jessica Smith: this particular business would have involved people being on site. In order, I think to like perform, like, I don’t know if it was like oil changes or like repairs or something like break services, I don’t recall exactly what.

Part of the automotive industry, so I’m just like, using it as a general, like,

Jamie Gruol: Humans were required

Jessica Smith: yeah, people were like, this was not, this was not like, automated, right? This was not done by computers. And so they did not have any payroll, but they did have a very significant. outside service provider line item. And so they, their file got pulled for what they believed was a misclassification of employees as independent contractors.

Again, no payroll on this business that was generating a lot of money. And, you know, the IRS clearly said you can’t run this type of business on independent contractors. Like that’s just, you can’t hire like an, you, I don’t like, you can’t bring in like an independent. mechanic and be like, Oh, you’re going to run, you’re going to run this business and, and I’m going to provide all the supplies and I’m going to give you the shop.

And I’m going to, you know, I’m going to provide all these things to you and you have to be here from eight until five. Like you can’t, that’s not an independent contractor, right? So you can’t have those people be independent contractors. It’s just the nature of the job. So he got, he got caught and and I think the intent there was At some point to like put the people on payroll, but like a lot of people do when they’re new in business, like you’re so cautious about your cashflow and just keeping the doors open sometimes that the thought of having to pay payroll taxes.

Is very overwhelming, like, extremely overwhelming, so I think that was the intent down the line, but unfortunately didn’t happen before they got picked up for audit. So, in the event of an employee reclassification audit the. The amounts that are paid to these people are verified through whatever records are able whether that be through bank records to show payments there weren’t even 1099s issued to these people, which was the other issue.

He had a very large,

Jamie Gruol: don’t know the next question, but

Jessica Smith: yeah, big,

Jamie Gruol: not on the up

Jessica Smith: big independent contractor expense without the issuing of the 1099s. 

Jamie Gruol: Yeah.

Jessica Smith: so, so there was a lot of kind of things working against this particular taxpayer. All in all, I think After everything got assessed. So, so the way that this works is in a reclassification audit, they take what was paid to that person.

They essentially reverse it as an independent contractor agreement or payment. They classify it as wages, and then they assess what would have what, what all the tax would have been. And so payroll taxes include employer matching. for FICA and Medicare taxes. So you have an employer tax that the employer contributes to those taxes.

But the other part of that is what is referred to as the trust fund portion of a payroll assessment, which includes all of the money that you were required to withhold from what you paid your employees. So this includes income tax withholdings, your social security, and your Medicare withholdings. So in the eyes of the IRS, when you as an employer Withhold those, but don’t pay them to the IRS or to the state, they believe, or the way they look at it is that you’re actually stealing because it’s the wages that you have agreed to pay them, and you are not, you are then not, not remitting those taxes, so you’ve essentially not paid them the wages, right?

So the IRS looks at it as theft. It’s got a very high level of like, hey, we are not going to take you. Take this easy on you.

Jamie Gruol: Yeah.

Jessica Smith: So after all that assessment, I think this person had, I think it was two tax years that he got caught for. So the assessment that they get is referred to as a trust fund recovery penalty.

And after they calculate what that is, Withholding environment would be, which they call the trust fund that then also gets assessed to the person, to the individuals, the responsible people who were responsible for withholding and remitting those taxes. So you have an assessment both to the business and an exact assessment that is mirrored onto the personal.

tax accounts for those responsible parties. And there can be tons of responsible parties. And unfortunately for this taxpayer, it was the husband and the wife that were both responsible, even though like their involvement in the business was literally minimal, but they were the owners. They were the ones, you know, responsible for the cash at the time.

So they were personally assessed. It was like around 350, 000. There’s a lot of money. So, so, so the assessment is it’s, it’s a mirror. So, so, You can have the business that’s assessed and the personal the individuals. And so when payments are made. Relative to let’s say a personal payment, it also reduces the business one.

So it’s not, it’s not assessed twice. It’s just going to appear because they want, they want to make sure that the IRS wants to make sure they collect from somebody. Right. And so it’s a 10 year,

Jamie Gruol: You’re not, you’re not

Jessica Smith: yeah, you can’t escape payroll taxes.

Jamie Gruol: to

Jessica Smith: So it’s,

Jamie Gruol: business

Jessica Smith: and, and the trust fund recovery penalty, we call it, it’s a 100 percent penalty.

So if you have 100, 000 assessment of, of taxes and 40, 000 of that was for the employer portion, but the other 60 percent was for the withholding from the employee’s pay, that 60 percent is also going to be assessed 100 percent to you as an individual, if you are considered a responsible party. So. You’re all, so the business and you were on the hook and it’s 10 years from when they assessed you with this.

So this particular taxpayer had this, like this big audit was off. Like it was awful. And, and the, the way we kind of like came to this conclusion that maybe the dad was the one running the business and that it was maybe a organized crime connection there. This man was super nice. Like he was so friendly.

But if you pissed him off, he had, like, a really, really big temper. And the interesting thing was, any time we would have discussions around, like, who was going, like, the, the father was actually paying the tax liability, like, because I think he just took, like, some responsibility for it. I don’t recall all of the nature.

To it. But I think there were some conversations that I may not have been a part of, but I think that some of the other attorneys were in, but there was there was a rumor that he made a comment to one of the council about. Like, you don’t want to get on my bad side, if I recall correctly. 

Jamie Gruol: The fishes.

Jessica Smith: yeah, like, I mean, I, and I, and I, and it’s hard to say, right?

Like, it wasn’t like a physical appearance thing. It wasn’t like a ethnic thing. It was just, it was just the way that this person Carried themselves the way that they were involved in the transaction, the way that they like really wanted to make sure, like, to make sure that their, their son was not the one responsible.

Like, he’ll pay for every, like, it was just, you just sometimes get like a vibe, right? Very. He was always so nice to me and to all of the, the support staff. But sometimes I remember sitting in there taking notes. I’m like, Oh my God, this guy is so weird. It’s so scary. Like, what is going to happen? But yeah, that was, that was a really interesting one because after the assessment, the next step was, can we settle this debt, because a trust fund recovery penalty is also a civil penalty that is not dischargeable bankruptcy.

It’s only dischargeable in the event that you qualify for an offering compromise. And. It is very hard to qualify for an offer and compromise. I know that everybody hears these radio ads about settle your debt for 500 on the dollar. And it’s not a negotiation. You don’t get to go to the IRS, slide an envelope across the table and be like, I owe a million.

Here’s 10, 000. It’s not like that, and I think it’s so funny that people think you, like, have any negotiation power in that scenario. It’s a formula, and the formula is how much money you earn that is used for allowable expenses, anything in excess of those allowable expenses, and literally it’s like what you need to not die, okay?

Jamie Gruol: Right.

Jessica Smith: what do you need to not die?

Jamie Gruol: and pranks and that’s it.

Jessica Smith: what do you need to be able to continue to live without sacrificing food, shelter, health insurance, those things, right? So, for some people, this is not a big number, and you could be earning an amount, like, over that, and they consider that to be, you know, The, the leftover ability to pay.

And you take that number and you multiply it by 12. And that’s the first step. And then you have assets, right? So this, this gentleman owned a business. There were hundreds of thousands of dollars of equipment that he had in that business. And it’s used in the formula for the offer and compromise. So you have to get an appraisal usually of anything that is of significant value.

It’s best to get an appraisal because the IRS will. Fight a like self reported about fair market value on an asset.

Jamie Gruol: Yeah.

Jessica Smith: anything that I would say is like of significant value and you’re going to have your own like threshold for what that is, but you’re going to want like a professional appraisal so that you can actually like support that, but that appraisal amount.

Is what the fair market value that the IRS is going to look at the of course allow for like the the fair market value is first reduced by any outstanding loans that you have on any of these assets and then that net number is then typically taken at 80%. So 80 percent of them that net number is what’s used.

For that offer and compromise because they assume that if you are expected to have to liquidate your assets You’re going to have approximately 20 in taxes So they want to make sure the taxes are paid but that formula for some people if that formula is More than what you owe you don’t qualify for an offer.

So so so it’s in this case I don’t think we were able to successfully Move forward with the offer because of the value of the assets in the business That were not secured by any liens or mortgages or anything like that and and realistically there was there was enough. Enough to then fully pay The liability and I think we did get them on like a like a currently not collectible collection alternative because it was really the assets that were the problem.

It wasn’t the income. It was the assets. But yeah, we, we, and I, and I, I don’t recall how it all kind of like ended at the end of the day, but the dad was like, if you can get this offer pulled off for me, like, I’ll pay. 100, 000 to settle this debt and we’re like, Oh my God, let’s try to do it so he doesn’t murder us all, but But yeah, that was that was an interesting in another interesting case to work on because you just like seeing like the the dad and the son like in the room together and you’re just like I don’t know what’s going on.

I’m just an outtaker.

Jamie Gruol: like you can see, you know, organized crime aside, like when you’re building a small business, when it takes off and it becomes, it grows quickly and you’re in over your head and you don’t know what you’re supposed to be doing. And so you’re just, Come doing again what somebody

Jessica Smith: Yes.

Jamie Gruol: and you’re like, okay, we’re going to do that.

Then you start thinking like, oh, maybe this isn’t the right thing and we should fix it. And you don’t, and then you get caught. Like you’ve got to feel for them to some degree. Like, obviously they made some poor choices, but it’s, it’s so. So sad when you hear that, because also like when they do take those assets into consideration and they have all this equipment that they’re using to actually run the operations, like, you can’t just sell those

Jessica Smith: Mm mm.

Jamie Gruol: be able to make income to be able to get out of your hole. Yeah, it’s just, it’s a really, really hard

Jessica Smith: This client was definitely, like, rockin a hard place. And it’s unfortunate because I do see a lot of similar financial crises. Like, you, you could literally make a million dollars one year and have nothing the next. And And I have clients that have experienced that. And unfortunately in those years where you’re making a million dollars and you think it’s always going to be like that and you have taxes that you have to pay.

And then suddenly you have no money to pay the taxes. It can be super scary. You can be faced with a very, very large balance, but like literally have. No ability to pay that liability. I highly suggest to anybody listening to this who happens to not be tax professional, like reach out and get help from a, from somebody who has experience with tax representation, a qualified enrolled agent, CPA, a tax attorney, if you think that there might be some criminal implications, because it’s not without hope, there are ways to put you in a spot because the, I like the IRS isn’t in the business of like decimating everybody.

It’s bad, it’s bad press, right? So, they go after a lot of the big guys, but if you truly do have, like, a financial hardship and you can qualify for some collection alternative that doesn’t involve, like, literally selling all of your assets, then, then they’ll do that. And and a qualified representative can can help you to get that.

And I was glad that he, in, in the case of the son, that he, his dad at least did help him. Connect him with appropriate counsel because I think what we were able to do was to get him on a collection alternative so that the The ideally if the income remained consistent for the life of that debt That they would have a minimal monthly payment and the debt would expire before it would be paid in full So it was it was a relatively a relatively good result for that taxpayer It was just unfortunate the method that he got in the mess in the first place

Jamie Gruol: yeah. Oh, it’s tough. And I will add to like, as we’re sharing these stories, if you’re a Pete, like interest is peaked and you’re like, I’m going to help people get out of

Jessica Smith: Yeah

Jamie Gruol: messy situations, check out enroll, becoming

Jessica Smith: Mm hmm. Mm hmm.

Jamie Gruol: an amazing program, the Hunter K EA, where she, she will mentor you and guide you through like how to build the skill sets of becoming an enrolled agent.

That’s so valuable to your being able to be more than just compliance, right? Like, people need support in

Jessica Smith: They need the help.

Jamie Gruol: probably need it. The help because untangling the webs that get woven sometimes unnecessarily and unknowingly can having somebody as an expert to step in and do that with you can really be life changing.

Like if Jess and the team hadn’t been there to help this family, even in their organized, primed ways unravel all of this, they wouldn’t have, you know, they could have been facing a lot stiffer penalties, a lot A lot of scary

Jessica Smith: Yeah.

Jamie Gruol: a lot scarier

Jessica Smith: Yeah Bye

Jamie Gruol: just want to, I want to leave you guys with that nugget today because there is such a great opportunity to move beyond just compliance and move into actually serving people and helping people out of situations.

So, all right, Jess, well, so much for sharing this. And if you did find this podcast, Enjoyable, entertaining, share it with a colleague. We would love to know that you’ve done that. You can also share a review with us down below where you’re listening. We thank you for being here with us and we look forward.

We have one more episode coming in our short series of crazy stories. And this one’s going to be a real doozy. It’s a timely one. So go, do go and listen to our podcast and we’ll see you in the next episode of diary of a tax practice owner. Thank you.