The Culprit Could Be Dead, But Local Tax Case Lives On

The FBI is inquiring whether FirstPay owner Mark Rothman is actually dead. (By Marvin Joseph -- The Washington Post)
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"I might have seen the IRS's point if they had notified us in the beginning," said Shelley Engel, B'nai Shalom's executive director. "But three years of not paying? You don't think they could have found another way of letting us know? If you're late on a credit card, they don't just stop with those letters in the mail. They call you, they serve you if they have to."

B'nai Shalom has 429 members and maintains a balanced budget of about $2 million a year. Like many temples, it runs a nursery and religious school, as well as adult education programs. The temple initially planned to settle with the IRS and hired a lawyer to handle the process. But Orenstein stepped in last year and offered to take its case pro bono.

Orenstein, a B'nai Shalom congregant, already represented the bankruptcy trustee, meaning he was guiding the investigation of FirstPay's practices, as well as the liquidation and recovery of its assets. With his knowledge of that case -- B'nai Shalom's dealings with the IRS are part of a separate administrative process -- Orenstein said he thought he could prevent the IRS from collecting anything from the temple. Perhaps, he said, he could even get some money back.

Before folding, FirstPay had made a final, $28 million payment to the IRS. Orenstein thinks that money should rightfully go back to FirstPay's creditors. He also challenged the agency's right to collect any more back taxes, arguing that it broke its own rules by letting FirstPay change its clients' addresses.

Maryland's federal bankruptcy court agreed in part. In August 2007, it ordered the IRS to return the $28 million to FirstPay's creditors. In his opinion, District Judge Peter Messitte called the IRS's approach "surprisingly arrogant." Despite that, Messitte said there was little he could do to stop the IRS from demanding payment in the future.

"While the IRS' disregard for its own procedures is troublesome, the Court finds no authority for it to impose any particular remedy under the circumstances," he wrote.

The IRS, which said it does not comment on specific cases, is appealing the ruling.

The FirstPay debacle is far from an isolated incident. In recent years there have been at least 11 major criminal prosecutions against fraudulent payroll operators, according to one government tally. But legislative efforts in response to the schemes have stalled. Versions of a bill that would have put tighter controls on payroll operators passed both chambers of Congress, then died before differences between the measures could be resolved. And initiatives to have payroll operators bonded have also failed to gain traction after lobbying efforts from the industry.

The IRS does have an online system that allows companies to check whether vendors are keeping up with tax payments. However, the system is poorly promoted, said Nina Olson, the national taxpayer advocate. She said the agency has generally resisted adding new safeguards, such as sending notices to both the taxpayer's old and new addresses when a mailing address changes.

"The IRS so far has been somewhat unresponsive to those things, and I find that somewhat disturbing," Olson said.

Bruce Friedland, an IRS spokesman, said the agency is taking a serious look at how to improve scrutiny of third-party payroll operators and how to handle address changes.

"We are actively working on how to best carry out a duplicate change of address notice to all business taxpayers who use third parties," he said. "In addition, in early 2007, we retrained those who process employment tax submissions to tighten scrutiny on address changes coming from possible third-party payers."

In the meantime, the FirstPay case drags on. If the IRS is ultimately forced to return the $28 million to FirstPay's former customers, the government says it will simply add it to the amount they owe in back taxes.

Orenstein said he is ready to challenge the IRS on that front as well. He said the agency has lost the paperwork proving how it allocated the money among FirstPay's clients, and without it, the agency has no basis for determining what is still owed.

"Their position is: 'Trust us. We wouldn't lie to you,' " Orenstein said.

Tax law experts said Orenstein's argument may be a stretch. The IRS can still pursue claims if it can show how much it is owed, they said, even if it lost FirstPay's records.

It may seem unfair, but even if they are victims of payroll fraud, companies are still legally responsible for making sure their taxes get paid, said George Yin, who teaches tax law at the University of Virginia.

"It's an awful situation," Yin said, "because the culpable company is in some sense getting off."