Ask The California Employment Tax And Payroll Tax Attorney – Internal Embezzlement May Not Constitute Reasonable Cause For Abatement Of Late Penalties
By Robert S. Schriebman
One of the saddest experiences I can recall in all the years I have practiced is the devastation caused by the internal embezzlement of monies earmarked for the payments of IRS and EDD payroll taxes. It confronts the unsuspecting employer with a 1 – 2 punch to the gut. The first punch is an in person visit from an IRS Revenue Officer informing the employer that several past quarters of payroll taxes have neither been paid nor returns filed. The second punch comes when the discovery of embezzlement is made. Most employers contact the police and this may be followed by a police report and an arrest. Criminal conviction, on the other hand, may be problematic.
I recall a recent case where a small payroll tax service embezzled the funds remitted to them for the payment of taxes. The embezzlement went on for almost one year before the unsuspecting clients were informed by the IRS that no quarterly returns had been filed, and no monies remitted. Some of the clients I represented owned several fast-food chains employing many workers. The amount of payroll taxes involved was staggering. And this did not include almost an additional 40% in accumulated penalties and interest. When confronted with the embezzlement by their clients, and demands to pay damages, the owners of the payroll company initially acted surprised, but soon could not be reached by phone. There is a lesson here. If you are going to use a payroll company for your compliance, choose one that has a national reputation and longevity.
Are the IRS and the EDD sympathetic to the situation? Will either or both agencies abate or remove late filing and late payment penalties caused by the embezzlement? Don’t count on it! In my experience, I have found that the “party-line” from the EDD is to let the poor employer know that he/she was responsible for hiring the employee and for supervising his/her activities. Their response: Why should the government suffer loss of revenue?
The recent case of Benchmarkportal, LLC, decided by the Office of Tax Appeals (OTA), illustrates the prevailing unsympathetic attitude of government agencies (OTA Case No. 19074997, April 16, 2020).
The Appeal of Benchmarkportal, LLC
In 2014 Benchmarkportal, LLC (Bench) failed to timely file its California FTB return. The FTB imposed several penalties against the LLC, including a late filing penalty, a late payment penalty, a per member penalty, and an estimated LLC fee underpayment penalty together with accruing interest. Bench paid the bill in full and filed a claim for refund requesting abatement of penalties and interest due to reasonable cause. Bench claimed to be the victim of fraud. A trusted employee, responsible for tax compliance, embezzled over $800,000. Bench contacted the police and had a police report that was offered into evidence at the OTA hearing. The OTA ruled that the embezzlement did not constitute reasonable cause for the late filing and late payment of the FTB 2014 return.
The standard for abatement of late filing and late payment penalties was established by the US Supreme Court in the Boyle decision, United States v. Boyle (1985, 469 US 241). The initial decision involved the issue of reasonable cause as an excuse for reliance on an agent such as an attorney or accountant for tax advice relating to the filing of a tax return. The Court concluded that “one does not have to be a tax expert to know that tax returns have fixed filing dates and that taxes must be paid when they are due. In short, tax returns imply deadlines…” In the Bench matter, the LLC relied on a trusted employee for tax compliance. The trust was misplaced as the employee turned out to be a crook. Was that reliance reasonable?
Courts have cited the Boyle case in circumstances involving the misconduct of an agent or employee of the taxpayer. (Kimdun Inc. v. United States (C.D. Cal. 2016) 202 F. Supp.3d 1136). In this case, reliance on a payroll service to make payments timely, was not sufficient to establish reasonable cause under Boyle despite the payroll service’s embezzlement of money that was intended for payroll tax obligations. In another case, Conklin Bros of Santa Rosa Inc V. US, 9th Cir 1993) 986 F2d 315, reliance on the taxpayer’s controller to make payments was not sufficient to establish reasonable cause because the company could not prove it was financially disabled from timely compliance. (the OTA never defined what it meant by disabled).
The OTA held that an ordinarily prudent person would have checked e-filing history and acknowledged records for the returns to confirm whether those returns had been transmitted, received, and accepted. An ordinary prudent business person would have exercised due care and diligence by monitoring the LLC’s bank account to quickly ascertain whether payments were being made to the proper taxing authorities. (Appeal of Scanlon, 2018-OTA-075P)
It appears from the Bench case and the other cases cited above, that business owners must be constantly diligent for any kind of government required compliance. The EDD and the IRS generally are not sympathetic to victims of embezzlement. The few federal cases deciding these types of scenarios are not sympathetic either. In the example I gave at the beginning of this article, a kind IRS Revenue Officer abated the penalties for two of six quarters but refused to abate the other four. She reasoned that after two quarters the employer should have exercised due diligence to discover the non-compliance. The EDD, in the same matter, refused to abate anything.
Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD and he is not employed by the EDD or any other agency of the State of California.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
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