Employers can streamline their business operations and easily meet filing deadlines and deposit requirements by outsourcing payroll and related tax duties to payroll service providers. However, employers that outsource some or all of their payroll responsibilities still remain liable for all taxes, penalties and interest due. We are advocates.

Cases such as Pediatric Affiliates P.A., (DC NJ, 2/23/06) illustrate that employers, and not their payroll service providers, are ultimately responsible for the payment of income tax withheld and both the employer and employee portions of Social Security and Medicare taxes. An employer can use a payroll service to remove much of the aggravation and paperwork associated with paying employment taxes. But out of sight shouldn’t mean out of mind. Employers remain responsible for all taxes, penalties and interest. That's true even if the failure to pay is entirely due to the payroll service provider's negligence or fraud. What's more, an employer may be held personally liable for certain unpaid federal taxes.

Our office strongly suggests that the address of record with IRS not be changed to that of the payroll service provider. If there are any issues with an account, the IRS will send notices to their address on file. So changing the address may significantly limit your ability to be timely informed of tax matters involving its business. You should ask the payroll service provider if they have a fiduciary bond. This could protect you in the event of default.

You should also ask the service provider to enroll in and use the Electronic Federal Tax Payment System (EFTPS). EFTPS maintains a business's payment history for 16 months and can be viewed on-line. So an employer can immediately confirm payments electronically through the internet or by phone. We recommend that you verify EFTPS payments as part of your bank account reconciliation process. In addition, EFTPS allows employers to make additional tax payments that their payroll service provider isn't making on their behalf (e.g., estimated tax payments).

There have been instances of individuals and companies acting under the guise of service providers, who have stolen funds intended for payment of employment taxes. There are other hazards in outsourcing payroll arrangements, as a recent case illustrates. DT Floormasters, Inc., a California company, contracted with Innovative Personnel Solutions, Inc. (IPS), an Indiana payroll service company, for standard payroll services. IPS leased employees to Floormasters. IPS paid the employees' wages, all employer taxes, federal, state, and local employee withholding taxes, worker's compensation insurance, medical insurance, vacation pay, and benefits. The problem was that IPS owed the IRS for unpaid taxes from transactions having nothing to do with Floormasters. The IRS levied the company's checking account, seizing funds that Floormasters had transferred to IPS. After IPS failed to make the payroll, Floormasters lost those funds and had to pay the employees itself. The district court held that once Floormasters transferred the funds to IPS's bank account, those funds were subject to the tax levy based on IPS' obligations. 

To summarize, using a payroll service is an excellent way to reduce your own aggravation and focus on your business. But in doing so, you still need to keep a careful eye on the process.