In 2016, Tennessee business owner Larry Thornton was sentenced to a year in prison and fined close to $10 million for his failure to pay over $8 million in employment taxes. Although his is a more extreme example of employment tax fraud, Thornton’s case is in line with the trend of fraud cases becoming more expensive, despite fewer cases being investigated.
In March 2017, the IRS watchdog, the Treasury Inspector General for Tax Administration, issued a report calling for a more focused strategy to deal with the shocking number of employment tax crimes. The report asserted the rate of these crimes – the willful failure to account for and deposit employment taxes – is on a steady incline. Although they say the number of employers conducting this type of fraud tripled in 17 years, there were 38 percent fewer assessments between 2010 and 2015, and fewer than 100 criminal convictions each year.
U.S. Employers Pay Over $5.5 Billion Each Year
New research by QuickBooks® Payroll has revealed the almost $123 billion cost of IRS penalties for employment tax violations since 1995. The study discovered U.S. employers are paying more than $5.5 billion per year.
The latest data comes from 2016, the most costly year for employers since 2009 – seeing a 41 percent annual increase from 2015 after a six-year decline. The annual cost of employment tax violations in 2016 reached more than $6 billion ($6,046,139,000). At the time of the study, data for 2017 had not yet been released by the IRS.
The number of tax violations assessed by the IRS has been on a consistent decline since 1995 (the first year for which data is available). Despite the spike in costs in 2016, there has been a 45 percent decrease in the total number of violations over 22 years.
On average, the annual cost of employment tax violations over the 22-year period for which data is available comes to $5,588,162,000. In recent years, this number has been trending downward, while the average cost for each violation has risen.
2016 saw a record high of $1,032 per violation – a 130 percent increase on the 1995 figure, when the average cost per violation was just $449.
More Costly Tax Violations
What these averages don’t reveal, however, is that some types of employment tax violations are far more costly than others.
The data shows employment tax fraud attracts the most heavy-handed response from the IRS compared to other violations. The average cost of an employment tax fraud violation is $23,598, compared to just $143 for bad check violations. The next most expensive type of violation, according to the IRS data, are tax estimation errors – costing $4,806 per violation on average. Tax errors follow closely behind in third place, costing employers $4,382 per violation.
Employment Tax Fraud
If we look more closely at employment tax fraud, we find the overall cost has trended downward over the past 11 years, while the average cost per violation has remained fairly constant, with fewer companies being prosecuted for fraud. The highest annual cost of employment tax fraud came in 2007, at $21.845 million.
In 2001, the average cost per employment tax fraud violations reached $71,110, a 22-year high, when the IRS brought cases against just 210 companies but recovered $16.277 million.
Tax Estimation Violations
Fines for tax estimation violations are on the decline, but the number of employers being prosecuted is not. The total annual cost of penalties for tax estimation violations has trended downward since 2005, dropping to $21,585 in 2016, when the IRS assessed more than 8,000 penalties. Data prior to 2005 is not currently available.
The average cost per tax estimation violation has also seen a noticeable decrease over the past 12 years for which data is available. The high point again came in 2006, at $12,666, but by 2016, the figure was down to just $2,859, on average, per violation.
The number of tax estimation violations rose significantly over the same period – from a low of 2,766 violations in 2005 to a high of 8,298 violations in 2016.
Tax Accuracy Violations
It’s a similar story for tax accuracy violations. As with tax estimates, the cost of these violations appears to be on the decline – down to $3.409 million in 2016 compared to a high of $22.601 million in 2008. But at the same time, the number of violations being assessed by the IRS is trending upward.
The average cost per tax accuracy violation has moved in step with the annual cost, dropping to the lowest on record in 2016 at $1,802, compared to a 2008 high of $8,703 per violation.
At the same time, the number of tax accuracy violations has trended up—though the 2016 figure (1,892 violations) is significantly lower than the 2012 high point of 2,964 violations.
Federal Tax Deposit Violations
The annual cost of federal tax deposit violations has declined somewhat since 1995, especially since 2000 when the total cost of IRS penalties reached a peak of $5.759 billion. In 2016, the cost of penalties was $3.086 billion – a 46 percent drop.
On the other hand, federal tax deposit violation costs have consistently increased since 1995—when the average per violation was $888 – to a high of $2,302 in 2016, making it the most costly year for federal tax violations on record.
Fewer Federal Assessments
The good news for business owners is, while the cost of each federal tax deposit violation is rising, the number of violations being assessed by the IRS has dropped significantly since 1995. Back then, the IRS found 4.265 million violations compared to just 1.341 million in 2016.
The number of penalties assessed for delinquency violations is also declining. In 1995, there were almost 2 million violations, compared to just over 1 million in 2016.
But the costs are still on the rise. Over the same period, the cost of delinquency violations has trended upwards. There was a notable spike in 2016, the second highest on record when the annual cost of IRS penalties reached $1.722 million. This was a 98 percent increase over the previous year.
In keeping with the theme, 2016 was also a notable year for the average cost of delinquency violations. It recorded, by far, the highest average cost per violation, at $1,567. By comparison, the lowest on record was 1995, at $298 per violation. That’s a 426 percent increase!
Failure to Pay Violations
Compared to other types of employment tax violations, failure to pay penalties have a relatively low average cost, but they are the most common. For example, in 2016, the IRS assessed 3.145 million failure to pay violations compared to just 233 for fraud. The numbers are, however, on the decline – down from a high of 4.621 million in 2006.
While the overall number of failure to pay violations is decreasing, the cost is on the rise – most markedly so in the 11-year period since 2006.
The logical conclusion of having fewer, more expensive violations for failing to pay employment tax is that average costs are rising. And the data shows this to be true. 2016 saw a record high in the average cost of failure to pay violations, reaching $365 compared to the 1995 low of $84.
Bad Check Violations
On average, of all the employment tax violations, bad checks cost employers the least. Violations for bad checks cost employers, on average, just $143. But they’re common. The IRS assessed 262,532 penalties in 2016 alone. The numbers have also been on the rise in recent years, peaking in 2014 with a 22-year high of 480,174 violations, compared to just 33,613 in 2010.
The spike in the number of bad check violations correlates with a similar rise in the overall cost of these violations, up from $4.273 million in 1995 to $59.518 million – an increase of 1,293 percent. Average costs per violation have followed suit since 2010, but with only a gradual upward trend over the entire 22-year period.
Employment Tax Errors and You
As your business clients’ tax and accounting professional, you may already help your clients report on taxes withheld and deposits made. But as their trusted advisor, you have an opportunity to make a bigger impact, helping explain the cost of employment tax violations to help them understand the importance of making these payments on time, and the risks of not doing so, so that their business doesn’t join the statistics.
Editor’s note: This article was originally published on the QuickBooks Resource Center.