An employer deducts for taxes but does not pay them to the IRS or social security, is employee liable?

Question

Suppose that an employee A has a boss B (who is also the company owner) that deducts payroll taxes and then keeps the money and reinvests it into his company. A has complained to B about this. As a result A has had problems with trying to receive a tax refund.

The IRS now thinks that A's account has been hacked and has instructed A to appear in-person and straighten this out in order to receive refund.

Is it possible that A will be stuck paying those takes a second time if B never pays the IRS as he should?

A has paychecks and stubs for every single payday as proof. A has W-2 forms also. What do tax law and regulations say about such a case?

Answer 1

I've litigated cases like these before. The IRS enforcement reaction is swift and severe.

Penalties for the employer are heavy and rarely waived. It would be rare for a business like this to stay operational long enough to issue a W-2.

A business like this would probably be shut down by the IRS and have the people responsible for the payroll function, at a minimum, promptly burdened with tax liens, within four to six months.

These cases also constitute a significant share of all criminal tax prosecutions. The odds of someone doing this spending several years in federal prison is high.

Generally speaking, if the wrongdoing is fully on the part of the employer without the collusion or knowledge of the employee, the IRS will not force the employee to double pay the taxes that should have been withheld by the employer in this situation. Instead, this IRS will try to recover the amounts that were withheld from the employees but not delivered to the IRS. It will seek to recover these amounts from the employer and also from other responsible persons in the organization (and from outsourced professionals) with the authority to pay the IRS who did not do so. There may be circumstances, if push comes to shove, where the IRS could collect from the employees in a case like this one (I've never had occasion to need to research that issue), but that would be the rare exception and not the rule, in practice.

On the other hand, if the employer simply does not withhold taxes or prepare W-2s at all, and either 1099s people who should have been classified as employees (or files no information tax returns at all), the IRS will generally insist that the employee pay income taxes on the full amount owed and that they pay the employee part of payroll taxes. It will also pursue the employer for the employer's share of payroll taxes. The employer will also be jointly and severally liable for any taxes that should have been reported and subjected to withholding that are not paid by the employee (perhaps because the employee spent all the money). Sometimes cases like this are also criminally prosecuted, but it is less common to do so.

Answer 2

You didn't mention the country (but say "IRS"), but in every country that I know the inland revenue will come down on this employer like a ton of bricks. (In one country where I actually worked for them for a few months, the rule was: If you are a company and can't pay all your bills and have to decide what to pay first, employee's taxes are the absolutely highest priority. You don't pay employee's taxes, you get closed down.

If you have paychecks proving that you were paid say $30,000 in a year, and you have been told that $10,000 in taxes had been taken out of your salary, then the inland revenue will notice that they should have $10,000 in taxes paid, and it's not paid, and since the $10,000 are YOUR money and not the company's money, it's theft. Your employer can go to jail for this, and having a limited liability company won't protect them.

Bad news for you: You have to pay your taxes. In your example, the inland revenue should realise that your income wasn't $40,000 with $10,000 taxes subtracted, but you were only paid $30,000 so in the worst case you might have to pay the taxes for $30,000.