If the IRS audits your Section 125 plan and determines that it’s not compliant, you are liable. Unfortunately, even if the problem stems from a plan vendor or bad advice from your CPA, you, the employer, are still liable for implementing a cafeteria plan that abuses IRS rules.
This doesn’t mean you have no legal recourse should this happen to you. But it does mean that when the IRS tries to collect taxes owed, you can’t necessarily get out of the tax or penalties because you relied on a third party. An experienced lawyer can be critical for helping you reduce penalties and minimize risks.
If the IRS is trying to collect back employment taxes, penalties, and interest because of issues with your Section 125 plan, you should contact the tax attorneys at Wiggam Law. We can help you not just deal with the IRS, but also explore your legal options if your reliance on what a third party told you led to this predicament.
Key Takeaways
- Tax liability falls on the taxpayer – The business that signs the tax filing is responsible for its accuracy, even if an error is the result of bad tax advice or misinformation from a benefit plan vendor or tax professional.
- Employers are responsible for any unpaid taxes, penalties, and interest. This responsibility applies even if the tax liability is the result of bad tax advice from a tax professional or fraudulent behavior by a plan promoter or vendor.
- Recovery options for the employer – Depending on the facts of the case and the content of any applicable contracts, the employer can seek reimbursement of any penalties and interest paid to the IRS by filing a separate civil suit against the tax professional or vendor.
- Talk to a tax attorney for help – Employers who are in trouble with the IRS for their Section 125 plans should consult with a tax lawyer to get a better understanding of their potential liability and what legal options they may have against third parties.
How the IRS Views Tax Liability
As a general rule, the IRS focuses on who signed the tax return, not who prepared it. Therefore, if your tax preparer made an error preparing a tax filing or you provided information based on bad advice from a Section 125 plan promoter, the IRS will come after you (not your tax preparer or the promoter) for the tax debt and any associated penalties and interest.
Employer Consequences
If the IRS decides to disqualify your Section 125 plan or retroactively reclassify employee deductions as taxable wages, then you will be liable for:
- Payroll taxes based on the value of the deductions are reclassified as income.
- Penalties, including the failure-to-deposit penalty and late payment or filing penalties.
- Interest back-dated to the original return due date and applied to both the tax liability and any applicable penalties.
Finally, there’s the potential for fines or penalties from the U.S. Department of Labor. This is because a problem with a Section 125 cafeteria plan also violates other federal laws in addition to the Internal Revenue Code. One notable example is the Employee Retirement Income Security Act (ERISA).
Why the IRS Doesn’t Let You Shift Liability to Third Parties
As mentioned earlier, in the majority of cases, any consequences for inaccuracies or mistakes on your business’s tax return fall on your business, not any other third party. However, an experienced tax attorney can often make a strong argument to the IRS that you acted with reasonable caution and should not face penalties.
That said, you are still likely to be liable for the tax due, as well as some penalties, but you may be able to take certain actions against the professional who helped prepare your tax filings and/or the vendor that sold the benefit plan to you.
Recovering From a CPA or Other Tax Professional
You have a few options if you hired a CPA, enrolled agent, tax attorney, or other tax professional to provide tax advice and/or help you prepare tax filings, but that tax professional gave you wrong information that contributed to you getting into Section 125 plan trouble with the IRS.
Bringing forward a civil lawsuit
Depending on the facts of your case, you could likely sue for negligence, malpractice, and maybe even breach of contract. Keep in mind, this is completely separate from any tax liability you have with the IRS. In other words, you would need to pay the IRS, and then go after your tax professional for reimbursement (also known as indemnification).
Asking the professionals to refile the returns
In reality, if your business finds itself in the crosshairs of the IRS for a mistake or error made by your tax professional, you probably won’t sue your professional. Instead, your tax professional would file any necessary amended filings with the IRS for free, as well as pay for the penalties and interest the IRS charges against you. It’s highly unlikely your professional would pay the unpaid payroll taxes, however. This is due to the fact that you would have always owed these, whether or not the tax preparer made a mistake.
Using a good-faith argument to avoid penalties
There’s one major exception to the above information that’s worth mentioning. Under Section 6664(c) of the Internal Revenue Code (IRC), the IRS will sometimes waive accuracy-related penalties (such as underpayment of tax) if you can show that there was “reasonable cause” for the error and you acted in good faith when making the error.
To rely on this exception, you must have given accurate and complete information to your tax preparer and have a reasonable belief that they knew what they were doing. In other words, you can potentially avoid an underpayment penalty if you made an honest mistake when relying on tax advice from your tax preparer, which you genuinely and reasonably believed to be lawful.
Recovering From a Cafeteria Plan Promoter or Vendor
As is the case with tax professionals, what went on between you and the third party doesn’t bind the IRS or obligate them to forego collecting taxes, penalties, and interest that you owe. Put another way, a vendor’s guarantee that a benefit plan complies with Section 125 of the IRC doesn’t bind the IRS whatsoever.
Any recovery from the business that sold you the benefits plan will depend on exactly what they told you, the reasonableness of your belief in what they said, and any contract you signed with them. Here are some options.
Relying on the terms in the vendor’s contract
When you retained the vendor, you likely signed a contract. Assuming that the contract is enforceable, its terms dictate what sort of recovery you have, if any, against the vendor.
For instance, if there were a provision that said the information you’re being provided isn’t tax advice, that all financial representations were hypothetical, and that you might still owe additional taxes despite what the marketing materials said, then it would be more difficult to recover any reimbursement or indemnification from the vendor.
If the contract doesn’t have a provision immunizing the vendor (or there’s an indemnification clause allowing you to get reimbursed for the vendor’s error or omission), then your best option would likely involve bringing a breach of contract lawsuit against them. Always consult with an attorney before making these types of decisions.
Exploring civil claims against the vendor
If the contract has a provision preventing you from successfully suing the vendor, you might still have a fraud or other civil claim against them. There’s also the possibility that you can submit a complaint to your state’s attorney general’s office. They might be able to investigate whether any other state laws were violated, such as statutes on unfair business practices.
What This Means for Employers
The bottom line here is that the responsibility of payroll tax compliance (and tax compliance in general) can’t be placed on anyone other than the taxpayer. This is true no matter what a vendor or plan promoter promises. Again, this is only from a tax law perspective. Even though the IRS can still recover the unpaid payroll taxes from you, you might still be able to go after the vendor, but that will be a completely separate legal matter that doesn’t involve the IRS.
What Employers Can Do In These Situations
If you’re in trouble with the IRS concerning your cafeteria plan, but you believe it’s due to a vendor misleading you or a tax professional giving you bad tax advice, there are a few things you can start doing:
- Gather and make copies of all plan documents, vendor contracts, and payroll records.
- Re-read the benefit plan marketing materials for fine print that might try to limit the vendor’s liability.
- Re-read the vendor contact to determine what sort of legal rights you might have against them.
- Pause any payroll deductions until you can confirm their legitimacy.
- Talk to a new tax professional (preferably a tax attorney), even if the old tax professional agrees to fix their mistake.
In many cases, it’s best to come forward to the IRS voluntarily, but you should strongly consider talking with an experienced tax attorney before doing so.
Understand Your Legal Options With Wiggam Law
It’s not fair to have to pay penalties and interest for someone else’s mistakes, or even worse, someone else’s fraudulent behavior. Despite this inequity, the IRS will still hold you responsible if there’s a problem with your Section 125 plan.
If you find yourself in this situation, Wiggam Law can examine your case and determine your potential tax exposure, identify your current options, and then advise you on what your next steps should be. To schedule a consultation, call (404) 609-1300 or use our online contact form.
FAQs about Section 125 Plan Liability
Are promoters responsible for tax due to non-compliant Section 125 plans?
Unfortunately, no. You are liable for the payroll tax that may be created due to a non-compliant Section 125 plan. However, an experienced tax attorney may be able to help you minimize penalties.
What should I do if I fail a Section 125 plan audit?
Contact an experienced tax attorney to help you dispute the audit findings, seek penalty abatement, or make payment arrangements on the tax liability. Unfortunately, even if you weren’t aware that the plan was non-compliant, you are still liable for the tax and penalties.
Do I have to pay the tax if I sue a Section 125 plan promoter?
Yes, tax debt and civil lawsuits are not the same. If you are liable for the tax, you must pay the IRS. If you bring a civil suit against a promoter, the courts can order the promoter to pay you, but the courts cannot legally reassign the tax liability from you to the promoter.
Sources:
https://www.irs.gov/payments/tax-preparer-penalties
https://www.irs.gov/pub/irs-tege/lesson4.pdf
https://www.irs.gov/pub/irs-wd/202317020.pdf
https://www.irs.gov/pub/irs-drop/n-05-42.pdf
