An electrician sued a Bel Air payroll company five years ago, alleging that it failed to submit payroll taxes for his employees, so he wonders why it took until last week for the Internal Revenue Service to start an investigation.
"They know what's going on," said Ron Biskup, owner of Biskup Electric LLC.
The authorities, including the IRS, were notified of the issue. And two other businesses also sued the payroll firm AccuPay Inc. around the same time, for similar reasons.
Still, it wasn't until after a veterinarian's office filed a suit on Feb. 27 that the IRS put its criminal division on the case. The vet's suit became the domino — after it was filed, a judge ordered AccuPay to preserve its records, the firm shut down and the Bel Air Police Department searched the company's office — that seems to have captured the IRS' attention.
Tax experts say such cases are far too common across the country. Advocates have recommended safeguards to identify red flags sooner. Yet they say the IRS has done little to prevent payroll companies from defrauding clients.
"I just can't believe this is happening again," said Lawrence D. Garr, an attorney with Dickstein Shapiro LLC in Washington.
Ten years ago, organizations that later became Garr's clients confronted a serious problem: A payroll servicer based in Silver Spring, FirstPay Inc., made off with millions of tax dollars that its clients thought had been paid to federal and state collectors.
"What the IRS did in light of FirstPay was finally start looking at these taxpayers as victims," said James Leith, the IRS' taxpayer advocate for Maryland. The IRS became more willing to negotiate over missed payments with harmed businesses, he said. But, he added, "to stop the problem … nothing's been done."
The IRS "enabled" FirstPay "to perpetrate and perpetuate its fraudulent scheme," wrote U.S. Bankruptcy Judge Paul Mannes, who sits in Greenbelt, in an August decision stemming from the FirstPay situation, which launched a decade of litigation.
Since FirstPay, there have been dozens of similar cases across the country that experts say should have encouraged change in the payroll industry's regulation. One of them is pending against a Rockville company called Focus Payroll LLC.
In the past five years, at least 24 owners and operators of payroll companies — who stole "about $300 million in employment taxes from thousands of client employers" — have been prosecuted by the Department of Justice, according to the Taxpayer Advocate Service's 2012 Annual Report to Congress, released in January.
Some of the issues at FirstPay were similar to allegations that have been leveled at AccuPay and its principals. They could not be reached for comment.
FirstPay's owner, Mark Rothman, siphoned millions of dollars off of hundreds of his clients' payroll taxes. But the victimized clients never heard from government collectors that they owed back taxes because Rothman had changed his clients' mailing addresses. Instead, he received those delinquency notices and no one was the wiser.
In 2003, Rothman died, FirstPay closed and the company was forced into bankruptcy. While figuring out their accounts, many of the firm's clients realized that they were behind on their taxes.
"The IRS failed to do due diligence by not noticing that several hundred companies and nonprofits suddenly had the same address, and all of them were delinquent in paying taxes," said Arthur Meyer Boyd, former finance director of the Friends Committee on National Legislation, which lost $170,000 in the FirstPay fraud.
Judge Mannes and others saw the IRS as complicit in the FirstPay scheme because there was no check on the company's ability to change its clients' late-payment notification addresses.
A simple safeguard that could have alerted FirstPay's clients to a problem — a dual notification system that sends an alert about the change of address to both the new and old addresses on file — is common practice for banks and online companies.
Despite urging by a trade group and the Taxpayer Advocate Service to institute such a system, the IRS has not done so.
"We would have caught that immediately," Boyd said. The Friends Committee would have known something was amiss if it had been told the payroll company changed its mailing address with the government, he said.
One AccuPay client said in a lawsuit filed last summer that the firm switched its address.
DuClaw Brewing Co. of Harford County received notifications from the IRS that it was behind on payments. When DuClaw brought it up with AccuPay, the payroll firm said the tax collectors "were at fault and that it [AccuPay] would reconcile the account," according to the suit.
Instead of remedying the problem, AccuPay changed the address on file with the collectors and began receiving DuClaw's nonpayment notices, the suit said. DuClaw alleged that AccuPay misappropriated $306,000 in tax payments over several years.
Whatever happened with AccuPay and its clients, tax experts say there's no reason it should have gotten as out of hand as is alleged.
"In light of what happened in FirstPay and in light of all the litigation … if [the IRS] allowed the same thing to happen again, then shame on them," said Jeffrey M. Orenstein, an attorney based in Montgomery County who represents the FirstPay bankruptcy trustee.
The IRS is a reactive agency, said Gerald W. Kelly, a tax attorney based in Columbia who used to be an IRS revenue officer. He is not surprised it took so long for the IRS to seriously look into AccuPay, he said, because it's common for businesses tight on funds to be delinquent with their taxes.
"That can go on for two, three, four years without the IRS doing a thing except sending out a letter," Kelly said.
Since taxes remitted by payroll companies are monitored by the IRS in the same way as taxes sent in by individual businesses, often the dots don't get connected when it's not the business' fault, experts say.
"The easiest way to track it would be to spot check the payments being made by the payroll companies," Kelly said. The IRS creates an audit trail for tax preparers, so why not for payroll companies, he said.
Such a tracking program is the Taxpayer Advocate Service's No. 1 recommendation to cut down on bad-actor payroll providers. The IRS, the Taxpayer Advocate Service said in its most recent annual report, should develop a program that will select a payroll company for audit when "when the number of delinquent employment tax returns of clients of a PSP [payroll service provider] exceeds an established threshold."
The IRS would not comment for this article. In its written response to the Taxpayer Advocate Service, the agency said "it may not be feasible due to the extensive programming costs and relatively small number of impacted accounts."
W. Randolph Shump, a former IRS trial attorney who practices tax law in Towson, agreed that the cost of implementing such a system might not save that many businesses from grief but likely would result in payroll service fees going up.
Instead, he suggested, states could require payroll providers to be bonded to insure against losses from fraud. (Maryland does not require payroll providers to be licensed or bonded.)
One thing that the IRS has instituted recently to cut down on payroll fraud is a disclosure requirement, said Pete Isberg, president of the National Payroll Reporting Consortium, a trade group for payroll providers.
Last year, the IRS started requiring payroll companies to send out quarterly reminders that say it is the client, not the payroll company, who is responsible to ensure that taxes are paid, he said.
That step, which could be ignored easily by payroll processors, doesn't satisfy the Taxpayer Advocate Service. The watchdog wants the IRS to take an active role in stopping payroll service fraud.
"The IRS is not doing enough early intervention," Leith said. Bad payroll service providers "can really bury taxpayers."
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