Watchdog Says IRS Had Success With Ghost Employers, But There’s More Work To Be Done

It seems that everyone has been ghosted by friends, co-workers, or old flings—but what about your employer?

IRS-Criminal Investigation (IRS-CI) has been leading efforts to identify employers that issue Forms W-2 to employees but do not submit the forms to the Social Security Administration, file employment tax forms with the IRS, or make any federal tax deposits. The IRS refers to these types of employers as “Ghost Employers.”

In June 2020, the IRS established the Ghost Employer Project to investigate this type of noncompliance with tax laws. Before this initiative, the IRS had not attempted to detect ghost employers. The Treasury Inspector General for Tax Administration, or TIGTA, recently released a report evaluating those efforts.

Their findings? The IRS has experienced some measure of success, but there is room for improvement.

Background

Employers are required to keep records of how much they pay their employees, as well as the amounts that may be withheld from paychecks. Withholding can include income taxes at the local, state, and federal levels as well as employment taxes.

Employment taxes—sometimes called payroll taxes—typically include Social Security and Medicare taxes, collectively referred to as Federal Insurance Contributions Act (FICA) taxes and federal unemployment taxes, in addition to other taxes. These taxes are deducted from employee paychecks and held by the employer until reported and deposited with the proper tax authorities. For federal purposes, there are two deposit schedules: monthly and semi-weekly.

Those taxes make up a substantial portion of federal tax receipts. In Fiscal Year 2022, the last year we have complete data, the IRS collected $1.42 trillion in employment taxes and $1.76 trillion in federal payroll income tax withholding. Together, that accounted for $3.18 trillion—or about 65%—of the $4.9 trillion total tax receipts.

Noncompliance

When employers withhold tax from employee paychecks but do not remit those taxes to the authorities, it creates a compliance problem. According to TIGTA, the failure to properly remit can happen for several reasons. That can include employers experiencing economic strain and unlawfully dipping into those withheld taxes to fund operations. Or, in more egregious cases, employers are committing fraud by willfully taking the withheld taxes to use for their own personal benefit, like buying luxury items, vacations, and real estate.

In some cases, employers may also engage in pyramiding. Pyramiding occurs when employers withhold taxes from employees but intentionally fail to pay those tax payments to the IRS quarter after quarter. These individuals may start a new business and again fail to pay up (rinse and repeat). Sometimes, these business owners may actually file accurate employment tax returns intending to comply with the law but then slip into noncompliance by not remitting the taxes.

Employers who intend to cheat may withhold taxes from employees but not file employment tax returns with the IRS or make federal tax deposits. Not filing the forms makes it hard to catch the employers—it’s as if they didn’t exist, earning them the ghost employer moniker.

Crime Fighting Efforts

Not remitting taxes that are withheld is a crime. It hurts the employees—since it’s essentially stealing money from their pockets—and the wider tax system by contributing to the tax gap. Bringing noncompliant ghost employers into compliance would reduce the tax gap associated with employment tax noncompliance.

(The IRS estimates the total true tax liability for 2021 to be $4.565 trillion. Of that, $3.877 trillion was paid voluntarily and one time. That difference—$688 billion—represents the tax gap.)

The number of those in noncompliance appears to be growing. In March 2017, TIGTA reported that the number of entities with 20 or more delinquent quarters grew from about 5,000 to almost 17,000 from FY 1998. However, in FY 2015, employment tax cases accounted for less than 3% of the cases initiated by IRS-CI.

That appears to be changing. For more information, the IRS turned to forms-matching, an easy way to evaluate compliance. Specifically, the CI Nationally Coordinated Investigations Unit (NCIU) initiated efforts in November 2017 to identify delinquent employers by matching Forms W-2 attached to individual income tax returns with the IRS payroll tax database to verify whether the corresponding taxes had been filed and paid. The initial data run before applying filters resulted in over one million entities that appeared not to have paid employment taxes.

The results were then used to identify thousands of employers that had been withholding employment taxes from their employees but needed to submit them to the IRS. These employers also did not file employment tax returns, and the IRS did not detect their noncompliance.

From June 2018 through May 2023, 354 leads from the NCIU with sufficient indicators of fraud were provided to IRS-CI field offices for investigation. As of May 2, 2023, of those leads, 136 were active investigations, 93 were adjudicated or in the pipeline for potential prosecution, and 125 were closed or discontinued.

TIGTA cited one case involving Jay Howard Prather, a 64-year-old Washington man sentenced to two years for failing to pay taxes. Between 2013 and 2019, Jay Howard Prather owned and operated Heritage General Building Contractors, with as many as 48 employees over that period. Prather withheld $1,095,388 in Social Security, Medicare, federal income taxes, and unemployment taxes from his employees’ paychecks. Instead of paying the money to the authorities, prosecutors say he used it to “buy expensive horses, exotic sports cars, and to remodel his multi-million-dollar lavish estate.”

Data-Centric

As part of a separate effort, the Research, Applied Analytics, and Statistics (RAAS) function also initiated a project to identify ghost employers. Using software filters, RAAS identified over 162,000 potential ghost employers with an estimated liability of $1.7 billion. From those, 280 were randomly selected to be reviewed by the Small Business/Self-Employed Division Field Collection and Examination functions. The RAAS function calculated the potential tax liability for the 280 entities at $125 million.

Field Collection was the primary lead for the project, referring some entities to other examination functions and IRS-CI. TIGTA found that the IRS did not fully track the results of the 280 potential ghost employer cases that RAAS selected. Overall, TIGTA’s analysis of the 280 cases found only seven cases involving ghost employers. The project resulted in 20 fraud referrals and identified the need to leverage an IRS application to improve the resources available to comply with employees working on employment tax cases.

According to the IRS, the pandemic hampered RAAS and SB/SE Division’s collaboration on tracking and investigating those 280 entities. The Ghost Employer Project ended in May 2022 (well before the federal COVID-19 declaration ended on May 11, 2023).

Misses

Not all of the efforts to identify ghost preparers were successful. That doesn’t mean that tax was not owed. According to TIGTA’s report, the most common reason for a case not matching the ghost employer criteria is that the employer has filed employment tax returns and racked up a balance due. That may be a liability, but it doesn’t prove that employers are not trying to evade detection—they’ve filed, just not paid.

When TIGTA reviewed the 35 cases worked by the SB/SE Division, the agency determined that only seven of them involved potential ghost employers (those seven did result in assessments).

TIGTA cites those seven cases as evidence of “limited success in identifying significant noncompliance activity” by ghost employers. TIGTA also pointed to a lack of coordination across operating divisions and areas hampering the project. Overall, TIGTA found that the project did not meet its goal of developing an SB/SE Division compliance strategy to address ghost employers.

However, TIGTA did note that technology will help in future identification and working of ghost employer cases.

Recommendations And Response

TIGTA recommended that the IRS:

1. Confer with RAAS for refinements to improve the identification of ghost employers;
2. Improve the tracking of enforcement actions and results and ensure that cases that do not rise to the level of IRS-CI involvement are placed into other civil enforcement work streams;

1. Address the recommendations provided by the Ghost Employer Project team; and
2. Remind Collection employees to refer ghost employer cases to Examination for potential assessment of civil fraud penalties.

Noting the project’s positive outcomes, IRS management agreed with all four recommendations and noted that it would take appropriate action to address them.

In her response to the report, Lia Colbert, SB/SE Division Commissioner, advised TIGTA that IRS-CI “places a high priority on investigating individuals who evade the payment of employment taxes.” She also noted that in FY 2023, NCIU referred 104 employment tax program leads to IRS-CI field operations.

You can read the entire report and the response here.