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

By Jordan Weissmann
Washington Post Staff Writer
Monday, October 13, 2008

By the time FirstPay Inc. shuttered its doors and declared bankruptcy in 2003, the Silver Spring company was managing payroll operations for about 1,500 businesses and organizations. What few, if any, knew was that owner Mark Rothman allegedly skimmed about $11 million of the taxes FirstPay was supposed to pay on its clients' behalf.

According to federal court documents, Rothman orchestrated the scheme for three years, using the money for a private yacht, houses and a company slush fund. By the end, he had defrauded approximately 250 companies, the government contends. FirstPay's former clients -- small businesses, nonprofits, churches and temples -- never saw the letters from the Internal Revenue Service alerting them that they owed back taxes because FirstPay had swapped their mailing addresses with its own.

Half a decade later, some of FirstPay's clients are still battling the IRS in a messy bankruptcy case to determine who gets the last of FirstPay's assets, and whether some of the businesses that fell victim to the scam will have to pay taxes a second time.

"We have one job and one job only. And that is either to stop the IRS from being able to collect from these people, or alternatively, to collect as much money as we can find . . . to pay everybody's claims," said Jeffrey Orenstein, a lawyer representing the bankruptcy trustee.

For most of the clients, the FirstPay saga began with a fax. For others, it was a phone call. A few were only clued in by newspaper reports. One by one, they learned in May 2003 that Rothman had been declared dead, and that his company was closing.

With their payroll company suddenly out of business, most of Rothman's customers scrambled to figure out the status of their accounts. It was only when some called the IRS to find out where their tax payments stood that they discovered they were in a deep hole.

As of last month, more than 150 companies had filed claims in FirstPay's bankruptcy case. The groups included nonprofits such as Christ Church Children's Center of Bethesda, which found itself holding a $72,000 back-tax bill, and small businesses such as Bernstein & Robinson Dermatology of Bel Air, Md., which owed $207,356. AIDS charities, radio stations and even the National Petroleum Council all claim to have been ensnared.

No lawyers came to court to represent FirstPay, even as allegations in the bankruptcy proceedings mounted against Rothman. He had allegedly used clients' money to pay for a 42-foot sailboat, a $184,000 vessel christened the "Get Too." He was also accused of misusing client funds to pay the mortgage on a home for his father-in-law, to buy property in Maryland, and to hand out performance bonuses to his employees. Lawyers presented evidence that Rothman had wired thousands of dollars to a pawnshop he owned.

Rothman was in the British Virgin Islands when he was declared dead in 2003 of non-Hodgkins lymphoma, and his family purchased a grave for him at a cemetery in Olney. However, in 2007, a federal bankruptcy judge wrote that the Federal Bureau of Investigation had opened an inquiry into Rothman and the fraud allegations, including the question of whether he was still alive.

The FBI says Rothman's case is ongoing but declined further comment. Rothman's wife did not respond to a request for comment.

In fraud cases, the IRS generally requires businesses to cover any taxes that weren't delivered. Two FirstPay clients, the Washington nonprofits Bread for the City and the Family Place, had their debts forgiven under new IRS guidelines that make it possible in some rare circumstances. But many, if not most, of FirstPay's victims have settled with the IRS, paying their taxes after the government dropped late fees and penalties. Most have joined the bankruptcy case with hopes to recover some or all of the amount of their settlement.

Some, however, have refused to pay. Temple B'nai Shalom of Olney, recently featured in a Jewish Week article about its problems, owes $67,000 in taxes, and more than $100,000 with penalties. The IRS has placed a lien on its building.

"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."

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