United States: Payroll Tax Compliance May Be A Problem For Many Tax-Exempt Organizations

On August 13, 2014, the Treasury Inspector General for Tax Administration (TIGTA) released its report on payroll tax compliance among tax-exempt organizations. According to the report, more than 64,200 tax-exempt organizations owed almost $600 million in unpaid payroll taxes in 2012. TIGTA recommended that the Exempt Organizations unit of the IRS should (1) coordinate with the payroll tax unit to improve detection of noncompliant tax-exempt organizations and (2) periodically review existing IRS payroll tax data to identify noncompliant tax-exempt organizations. Although the IRS director of the Exempt Organizations unit rejected these recommendations, the report is a timely reminder to tax-exempt organizations to comply with payroll taxes.

TIGTA reviewed existing IRS data to determine that 64,200 tax-exempt organizations owed almost $875 million in unpaid federal taxes (including payroll taxes, unrelated business income tax, excise taxes, penalties and interest). This number is a small percentage of the almost 2 million recognized tax-exempt organizations, but future enforcement efforts are likely to impact all tax-exempt organizations. Most of the noncompliant organizations owed less than $10,000 each. However, 1,200 of those organizations owed more than $100,000 each and five organizations owed more than $10 million each. TIGTA reported that the $875 million figure is likely an understatement of the true federal tax debt owed by tax-exempt organizations.

Tax-exempt organizations should consider the following key points from the report:

  • Unpaid payroll taxes can expose organization leaders to civil and criminal penalties. While tax-exempt organizations are exempt from paying federal income tax under section 501(a) of the Internal Revenue Code (the Code), they remain subject to other federal and state taxes (including payroll taxes, unrelated business income tax and excise taxes). Payroll taxes include Old Age, Survivors, and Disability Insurance (OASDI or Social Security tax) and Medicare. Failure to withhold these taxes from the wages of compensated employees can expose a tax-exempt organization's leadership to personal liability for civil penalties. Willful noncompliance can lead to criminal charges.
  • Unpaid payroll taxes are on the IRS radar. The federal government has long been aware of noncompliance by tax-exempt organizations on this issue. In 2007, the Government Accountability Office found that tax-exempt organizations owed approximately $642 million in unpaid payroll taxes. As a result of the GAO's finding, the IRS Tax Exempt and Government Entities Division initiated several pilot projects to increase enforcement efforts, resulting in the assessment of taxes and penalties of more than $57 million. TIGTA's report indicates that the IRS already has the data and means to efficiently identify noncompliant tax-exempt organizations. However, the response of IRS management to the report indicates that there is some internal resistance to making better use of such data.
  • Unpaid payroll taxes may become an audit risk in the future. TIGTA found that unpaid payroll taxes could be an indicator that a tax-exempt organization is involved in various other impermissible activities. In addition to the big picture analysis of noncompliant tax-exempt organizations, TIGTA closely examined 25 tax-exempt organizations that "appeared to be among the worst examples of organizations with significant unpaid Federal tax debts." All of these organizations had unpaid federal tax debt, including payroll taxes, ranging from "$300,000 to more than $3 million per organization." TIGTA's auditors determined that almost all of the officers of these organizations were involved in "abusive activity," such as not filing personal tax returns or underreporting their wages. As a result of TIGTA's review, several of the organizations were examined by the Exempt Organizations unit for abusive activities such as "political campaign intervention, substantial legislative activities, excessive personal benefits, inappropriate loans, and other fraudulent issues." The Exempt Organizations unit also examined several of these organizations for excessive executive compensation, questionable governance practices or inconsistent tax filings. TIGTA recommended that the Exempt Organizations unit identify tax-exempt organizations with "significant" unpaid payroll taxes as a method for identifying organizations that are likely to have other tax-exempt issues.
  • IRS enforcement efforts face obstacles. TIGTA's report noted that enforcement actions against noncompliant tax-exempt organizations are hindered by the charitable nature of such organizations and by the current language of the Code. The usual IRS collection methods include levies and asset seizure, but the report noted that such methods could shut down a tax-exempt entity and eliminate the public benefits stemming from the entity's operations. Additionally, the IRS cannot revoke the tax-exempt status of an organization or require changes to an organization's governance solely for the failure to pay the payroll taxes.

TIGTA recommended that the Exempt Organizations unit treat unpaid payroll taxes as an indicator of other compliance issues with the tax-exempt rules. The IRS rejected this recommendation by taking the position that IRS data on payroll tax compliance is not relevant to the unit's function in identifying issues of private benefit. Although the rejection of this recommendation is an indication that unpaid payroll taxes will not be given special attention by the Exempt Organizations unit in the near future, the IRS could easily change its policy on this issue without notice to taxpayers. There is no requirement that the IRS publish a regulatory notice or other guidance indicating that it will begin to cross-reference payroll tax data with other data received from tax-exempt organizations. For this reason, tax-exempt organizations should ensure that they continue to comply with their payroll tax obligations.

To review the actual text of TIGTA's report, go to www.treasury.gov.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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