Taxable Talk

I’ve heard many times that cash is king. Well, that’s not always the case as Leroy Felt, Jr. discovered.

Mr. Felt was the owner of Woody’s Construction in Margate, Florida. He decided to pay his employees in cash. That’s absolutely legal…as long as you make all the necessary payroll deductions. Mr. Felt had a better idea.

He wrote corporate checks to various companies and individuals. They, in turn, gave Mr. Felt the cash (less a small fee kept for the service). Mr. Felt then used the cash to pay his employees. Mr. Felt thought he didn’t need to worry about those pesky payroll taxes.

The government doesn’t like it when you violate trust fund taxes. People who do so end up in prison when they’re caught and they end up paying the tax plus penalties and interest. Mr. Felt got caught, pleaded guilty, and was sentenced to ClubFed for four years.

Paying people under the table is a bad idea. If you get caught it’s almost a certainty that ClubFed is in your future.

This week’s tax evasion stories share a common theme: the alleged evaders (and those convicted) should have known better.

Let’s start in Sin City, where a personal injury attorney liked cash as a way to conduct his business. There’s nothing wrong with that, but when you don’t declare the cash income and you purchase assets and hide them in others’ names, problems can arise. When the total amount involved is $2 million over six years and there’s a sham child support agreement, it’s trouble with a capital t. Edmund C. Botha was found guilty last week of one count of tax evasion. Based on federal sentencing guidelines, Mr. Botha is looking at about three years at ClubFed plus probable restitution when he’s sentenced in early 2009.

Moving east, Danny Gladden is the former tax collector of Crawford County, Missouri. He was elected in 1991 and soon after discovered a lucrative side job: He embezzled from the county. A state audit discovered the missing funds in 2005, and he was later convicted of theft and sentenced to seven years in state prison. This past week he was convicted of tax evasion. Mr. Gladden forgot that tax must be paid even when the source of your income is stealing. Given that he owed about $82,000 in tax he’s looking at about two years at ClubFed based on sentencing guidelines.

Next, let’s look at two stories that both feature payroll taxes. First, the US Department of Justice calls this “the largest cash wage scheme in Massachusetts history.” Now, there’s nothing wrong with paying employees in cash—it’s completely legal. But you still must withhold payroll taxes, and you still must report them accurately to the government, and you do have to remit them to the appropriate agencies. What happens when you don’t do any of those things? Well, if you get caught, tried, and convicted, and the amount involved is over $43 million, you’ll likely find yourself at ClubFed for a long time.

And that’s exactly what happened to husband and wife Daniel and Aimee King McElroy. About $43 million in payroll was paid under-the-table, with the loss to the IRS being around $10 million and the loss to workers compensation companies was $7 million. In total the husband and wife were each found guilty of 19 counts. The husband was previously sentenced to 108 months at ClubFed; last week the wife received 78 months. They were also ordered to make restitution of $9.1 million.

Our final story comes from Worcester, Massachusetts. Attorney Christopher Uhl allegedly withheld money from his employees’ wages for payroll taxes. That’s good. He also allegedly didn’t remit that money to the federal government. That’s not good. He’s been indicted on six counts of tax evasion and six counts of willful failure to pay taxes.

If you have employees make sure you’re in compliance with payroll taxes. This is not an area to skimp on. Those taxes are called “trust fund taxes,” and the federal government and state governments almost always vigorously go after individuals who withhold but don’t remit. Committing this sort of tax evasion is a losing proposition.

I’ve said this before but it bears repeating—especially on Labor Day. If you want to get in trouble with the IRS either withhold payroll taxes and don’t remit them to the IRS or pay your employees under the table (thus not being in compliance with trust fund taxes). Either method starts you quickly on the road to ClubFed.

Thomas Carbo of Wayne, Pennsylvania did the latter. He decided to improve his business’ profitability by paying his employees under the table. He did temporarily save on his payroll tax expense…until he was caught. He ended up defrauding the government out of $168,000.

He was apparently caught as a result of a kickback scheme in nearby Norristown. His business appears to have been a Norristown vendor. The government subpoenaed his records but he didn’t comply with the subpoena; he’s accused of destroying the records instead. The government then investigated, looked at his bank records, and then discovered the tax fraud.

Mr. Carbo has pleaded guilty to one count of conspiracy to defraud and 17 counts of failing to collect and submit the payroll taxes. While he faces up to 90 years in prison and a fine of up to $4.5 million, federal sentencing guidelines suggest he’ll receive a little over two years at ClubFed.

What happens if you use a payroll service and they don’t forward the deposits to the IRS and your state tax department? The payroll company will be in trouble, but the employer is still liable for the deposits. That’s why you should only use reputable companies.

Premier Data Solutions doesn’t sound like a payroll company, but that’s one of the services they offered. The company, located in Kankakee, Illinois, served a variety of employers, including the Kankakee Valley Park District, a local high school, and a pizza parlor. When the IRS notified these companies that their payroll deposits haven’t been made, they contacted the Kankakee Police. Currently both local and federal investigators are looking into Premier.

Complicating the matter is that Premier was sold earlier this year and, remarkably, the payroll deposit problems apparently weren’t noticed.

Joe Kristan recommended last week that employers should check with the IRS to make sure that their payroll deposits are being received. That’s excellent advice. In any case I suspect lots of people are looking into whatever happened with the money Premier received but didn’t remit to the government.

News Story: The Daily Journal

One of the surest methods I know to get the IRS upset with you is to withhold payroll taxes and not remit them. Payroll taxes are called trust fund taxes; I’ve yet to know of a time when the IRS hasn’t gone after a business that failed to remit those taxes. I’m also unaware of any case where the IRS hasn’t pursued a payroll service who failed to remit trust fund taxed on behalf of employers it serviced.

James McLamb, of Raleigh, North Carolina, was CFO of the Castleton Group. Castleton serviced about 100 employers in the Research Triangle area of North Carolina. Serviced, though, may be the wrong word to use for Castleton; scammed appears to be more apropos.

McLamb had a unique method of handling trust fund taxes. He’d calculate the correct amount of taxes, accept those remittances, and then change the numbers to much lower figures. He’d use the lower numbers to report payroll to the IRS and the North Carolina Department of Revenue. It’s unclear from the news story where the $8 million that was supposed to go to the IRS ended up; suffice to say it didn’t end up in the U.S. Treasury and likely lined McLamb’s pockets.

The fallout from this mess is what you’d expect. McLamb has pleaded guilty to defrauding the United States; he’ll likely be sentenced to a lengthy term at ClubFed later this year. Castleton is bankrupt; it’s owner blames McLamb for the company’s problems. The employers who trusted Castleton still have to remit the taxes to the IRS & North Carolina.

I strongly advise my corporate clients to use a reputable payroll service. This is not an area to skimp on—the penalties are high for mistakes and owners can and are held personally liable when mistakes occur. Finally, if you think that an idea like McLamb’s will work over the long term you’re badly mistaken. Trust fund taxes are heavily scrutinized and the government will come after you.

I used to work in Stockton. And I know that I have at least one reader who resides there (a former co-worker). He is probably already aware of the problems that the Sang family faces.

Richard Sang, his wife Amber Lao, and their sons Brooke Sang and Richie Sang own several restaurants: Mallards in Stockton and Modesto, the Cedar Creek Inn in Palm Springs, and the Fish Market and Grill on the Lake in nearby Mission Viejo. The Stockton Mallards closed in October; the Modesto Mallards closed in November. Many restaurants fail (it’s a very tough business). However, both Mallards failed in spite of the owners allegedly pocketing payroll taxes withheld for the state.

San Joaquin County Deputy District Attorney Sudha Rajender told the Stockton Record that “[The owners] were withholding [the taxes], but they were pocketing it.” In total, the four are facing 36 counts of fraud and tax evasion. The elder Sang has been through charges like these before; he was convicted on federal charges in Washington state in 1991.

Meanwhile, California’s Employment Development Department (EDD) has already fined the owners $100,000 for not having workers compensation insurance at the Modesto Mallards. And the owners are facing a $1.6 million lawsuit over defaulted loans and owe $10,000 to Stanislaus County for unpaid property taxes.

Currently, the Mission Viejo restaurant remains open. I hope that continues (at least for the short-term); I am part of a group that has a breakfast meeting there every Friday morning. Given that Mr. Rajender told the Marin Independent Journal, “I’ve never seen a case like this before. These guys have gotten away with this for some time, and nobody has been interested in prosecuting them before. It’s very complicated.” I suspect we may soon be looking for a new location to meet.

Modesto Bee Story Here

There’s a sure-fire method to get the IRS upset with you. Just withhold trust fund taxes from your employees (FICA and income tax) and don’t send them to the IRS. I can almost guarantee you that bad things will happen to you.

And if at the same time you don’t file your annual FUTA (federal unemployment tax) returns and your personal income tax returns, the IRS may want to send you to ClubFed.

Just to make sure you get some attention you can also be accused of defrauding some of your customers. And as long as you’re going this route, you might as well allegedly defraud your investors.

That’s what Marengo, Illinois contractor John M. Volpentesta is accused of. He faces 23 counts of mail fraud, wire fraud, and tax fraud. He allegedly defrauded customers investors out of over $1 million and didn’t remit federal trust fund taxes of $164,999. And, yes, it’s alleged that he didn’t file the FUTA tax returns from 2003 – 2005 and that he and his wife didn’t file three years of personal tax returns. If found guilty, Mr. Volpentesta is looking at a lengthy stay at ClubFed.

Trial will probably be next summer in Rockford, Illinois.

We received an email regarding the post we did on Ace Tire & Parts. The owners of Ace are accused of violating federal employment laws and have each pleaded guilty to one count of tax fraud.

In any case, we were asked the following:

“just read your article. where did you get your information for bozo scheme failed? what makes you think these guys are going to club fed? what do you know about pa tax laws with regard to this case? isn’t this a rather common practice among small businessmen across the country? give me your thoughts.”

Well, as to where I got the information, it was published in multiple places, including the Pittsburgh Post-Gazette. I think they’re going to prison because of the nature of their crime. These individuals robbed what are called “Trust Fund” accounts. When I wrote, “And the DOJ and IRS really, really don’t like violators of employment tax laws.” And that’s what they did, to the tune of somewhere between $400,000 and $1,000,000.

As to whether this is a common practice, definitely not. Anyone who thinks that most small business owners steal from employment tax trust fund accounts needs to think that through. Do you really believe that most small business owners are tax cheats? Thankfully, most Americans do pay their taxes, and most business owners correctly forward the employment taxes they collect to the government.

Please don’t try this yourselves.

You have a successful business (in this case, Ace Tire & Parts of Coraoplis, Pennsylvania). You decide that you don’t have to pay payroll taxes; instead, you’ll make your employees checks payable to “Cash” and as reimbursements for nonexistent expenses. Your controller agrees to this highly illegal scheme. You save on payroll taxes and your employees avoid income taxes.

And then the IRS finds out.

The two owners of Ace Tire & Parts, Richard & John Schwartz, and the controller, Richard Connell, all pleaded guilty to one count of tax fraud. Given that the tax loss to the IRS was between $400,000 and $1 million, the three are looking at about three years at Club Fed and, I assume, restitution to the IRS. And I wouldn’t be shocked if the Commonwealth of Pennsylvania looks at this crime, too.

For the record, this kind of fraud rarely goes undetected. And the DOJ and IRS really, really don’t like violators of employment tax laws.

There’s one task that I insist that my business clients do not perform themselves: payroll processing. Given the penalties and legal liability issues, I urge them to go with an extremely reputable company. There are several that do an excellent job; this post is not about which one is my favorite.

Rather, I was reminded by Joe Kristan’s post yesterday in Roth Tax Updates about the dangers of using certain companies. If an employee of a payroll company steals your tax deposits, what would happen? If you’re with a large, reputable firm, the deposit will be made, and the payroll company will go after the employees involved. If you’re with Fly-By-Night Payroll, expect the IRS and the FTB to knock on your door.

Here are three questions you should always ask of your payroll service company:

- Will they make all appropriate/required tax deposits in all the jurisdictions in which we operate? Will they be done on a timely basis?

- Assume that the deposit is not timely made. Who will be liable for the interest and/or penalties?

- Will you put this guarantee in writing?

Of course, you should get references, especially for small companies. Yes, cost is a factor you need to consider when choosing a payroll company. But so is the ability to handle the inevitable errors that will occur.