IRS nonacquiesces PEO payroll tax refund decision

Tax Hot Topics newsletterThe IRS issued an action on decision (AOD 2020-01) stating that it would not acquiesce to the holding of the U.S. District Court for the Middle District of Florida in Paychex Business Solutions v. United States, 2017 WL 2692843 (M.D. Fla. 2017).

In the case, Paychex, a professional employer organization (PEO), sought a refund of Social Security taxes it overpaid for its clients’ employees. PEOs handle the payroll, withholding and related reporting obligations of its client companies. Pursuant to payment arrangements with its clients, Paychex would charge its clients’ bank accounts for the amount of compensation and related withholding to be paid for the clients’ employees. Amounts charged would be transferred to Paychex’s bank account, and Paychex would pay out the compensation and withholding owed for its clients’ employees with these transferred funds. Upon initiating a charge, Paychex did not have knowledge of whether its clients had sufficient funds in their bank accounts to cover the owed amounts. In instances where clients had insufficient funds, Paychex would pay out the owed compensation and withholding using its own funds from its bank account and pursue collection from the delinquent clients afterwards. Clients did not have access to or control over Paychex’s bank account.

In the tax years at issue, Paychex erroneously overpaid the employer share of Social Security taxes on the employee wages of its clients. The IRS denied Paychex’s request for a refund of these overpaid taxes because it did not consider Paychex to be the common law employer of its clients’ employees. Paychex argued that it was entitled to a refund because it was the statutory employer of the employees and brought the dispute to the Florida District Court. Upon review, the District Court determined under case law that the statutory employer is the one who controls the payment of wages and ruled in favor of Paychex. In its reasoning, the District Court stated that Paychex had control of the payment of wages to its clients’ employees because it had exclusive control over the bank account used to pay the employees.

Pursuant to its AOD dated March 16, 2020, the IRS will not acquiesce to the decision in Paychex, stating that its position is that an entity is not in control of the payment of wages if payment is contingent upon, or proximately related to, the entity having first received funds from the common law employer.

Jeff Martin
Washington National Tax Office
T +1 202 521 1526

Keith Mong
Managing Director
Washington National Tax Office
T +1 202 521 1554

James Sanchez
Senior Associate
Washington National Tax Office
T +1 202 861 4107

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