How to Report Employer Withholding Abuse

Employers are legally required to withhold federal income, Social Security, and Medicare taxes from employee paychecks. These funds are held in trust before being remitted to the government. Withholding abuse occurs when a business fails to follow the legal requirements for managing and paying these taxes, which can lead to significant consequences. The responsibility for correct withholding, reporting, and payment rests solely with the employer.

Common Schemes of Withholding Abuse

Failure to Withhold

One form of withholding abuse involves paying employees “under the table” in cash or another untraceable form to avoid creating a paper trail. This practice bypasses the entire payroll process, as the employer fails to deduct any taxes. Employees paid this way lose out on benefits tied to Social Security and Medicare contributions, such as retirement and disability benefits, because no record of their earnings is reported to the Social Security Administration.

Withholding but Not Remitting

A deceptive scheme known as “pyramiding” occurs when an employer deducts taxes from a paycheck but illegally keeps the money instead of forwarding it to the IRS. The employer uses these funds for its own purposes, such as covering operating expenses. Businesses engaged in pyramiding may accumulate significant tax liabilities and sometimes dissolve and reform under a new name to evade collection.

Employee Misclassification

Another method of avoiding payroll taxes is to improperly classify workers as independent contractors. Employers are not required to withhold income taxes or pay their share of Social Security and Medicare taxes for independent contractors. The IRS determines a worker’s status based on criteria related to behavioral control, financial control, and the relationship’s nature. An employee is someone for whom the business can control what work is done and how it is done, whereas an independent contractor controls the method and means of their own work.

Consequences for Non-Compliant Employers

Trust Fund Recovery Penalty (TFRP)

When an employer withholds taxes from an employee’s pay but willfully fails to remit them to the IRS, the agency can impose a Trust Fund Recovery Penalty (TFRP). This penalty is not assessed against the business entity but is charged directly to the “responsible persons” within the company. A responsible person can be an owner, corporate officer, or any individual with the authority and duty to collect and pay the taxes. The TFRP is equal to 100% of the unpaid trust fund taxes, and the IRS can seek to collect this amount from the personal assets of the individuals deemed responsible.

Civil Monetary Penalties

Employers may also face other civil penalties. The IRS can assess a failure-to-deposit penalty of 2% to 15% of the unpaid tax, depending on how late the payment is. A failure-to-file penalty of 5% per month, capped at 25%, can be applied if payroll tax returns like Form 941 are not submitted. Interest also accrues on all unpaid taxes and penalties from their due date.

Criminal Charges

In cases of willful failure to comply with employment tax laws, consequences can escalate to criminal prosecution. This is a felony punishable by fines up to $250,000 for an individual or $500,000 for a corporation, and imprisonment for up to five years. The Department of Justice and IRS Criminal Investigation division actively pursue these cases, especially when employers use withheld funds for personal gain. A conviction can also include restitution orders.

Information Needed to Report Suspected Abuse

Required Information and Form 3949-A

To report suspected withholding abuse, the IRS collects information on Form 3949-A, Information Referral, which can be downloaded from the IRS website. The form guides you through providing a detailed description of the alleged violation. You will be asked to check boxes for the type of violation and use a narrative section to explain the situation in your own words.

You should be prepared to provide:

• The name and address of the non-compliant business.
• The name of the owner or responsible individual.
• The business’s Employer Identification Number (EIN) or the individual’s Social Security Number (SSN), if you have it.
• The tax years involved and an estimate of the unreported wages or unpaid tax, if known.

Supporting Documentation

While not required for the initial submission, gathering supporting documentation strengthens your report. Do not send original documents with your initial report, as the IRS will contact you if they need to examine your records. Helpful evidence can include:

• Pay stubs showing deductions that were not remitted.
• Copies of Form W-2 or Form 1099.
• Bank statements showing cash payments.
• Any correspondence related to your employment or pay.

The IRS Reporting Process

Submission Method

Form 3949-A must be printed and mailed to the designated IRS address listed on the form, which is the Internal Revenue Service center in Ogden, UT. Do not send the form to a general IRS address, as this could cause delays. You can also submit a letter with the same detailed information instead of using the form.

What to Expect After Submission

After you mail the report, your direct involvement is usually complete. Due to strict taxpayer privacy laws, the IRS cannot provide you with updates on the status or outcome of the investigation. The process is confidential, and you should not expect follow-up communication unless an investigator needs more information from you.