To amend the Internal Revenue Code of 1986 to establish procedures relating to the attribution of errors in the case of third party payors of payroll taxes, and for other purposes.
- Sponsor
- Rep. Thompson, Mike [D-CA-4]
- Committees
- Ways and Means Committee (primary)
- Last action
- May 6, 2025
Bottom line
This bill clarifies liability for payroll tax errors between employers and their third-party payroll providers, aiming to balance accountability and provide a safe harbor for certain tax credit reporting.
What it actually does
This bill amends the Internal Revenue Code of 1986 to establish clear rules for attributing liability when errors occur in payroll tax payments handled by third-party payors. It specifies that if a third-party payor has 'constructive knowledge' of an error in an employer's certification, both the employer and the payor share liability for that portion of the error. However, if the payor lacks such knowledge, the employer bears sole responsibility. The bill also includes a safe harbor provision for payroll tax credits and protects employers from audits solely based on their payor's errors with other clients.
Proponents argue
Proponents argue that this bill brings much-needed clarity and fairness to the complex landscape of payroll tax compliance, particularly for small and medium-sized businesses relying on professional payroll services. They contend it protects employers from being solely responsible for errors their payroll provider knew about and incentivizes providers to exercise due diligence, while also preventing innocent employers from being penalized due to their provider's unrelated mistakes.
Opponents contend
Critics might express concern that the definition of 'constructive knowledge' and its associated safe harbor could be too broad, potentially making it difficult for the IRS to hold third-party payors accountable for errors they should have identified. They may argue that this could shift too much liability back to employers or complicate tax enforcement, potentially reducing the overall incentive for rigorous error detection in payroll processing.
The bill is concise and can be read quickly, but understanding its full implications requires careful consideration of tax code definitions and liability attribution.
Section 1, adding new IRC Section 3513(a)-(c)
Attribution of Liability for Payroll Tax Errors
This provision establishes rules for who is responsible when an error occurs in payroll tax payments. If a third-party payroll provider (like a payroll service or PEO) has 'constructive knowledge' (meaning they knew or should have known) of an error in an employer's tax certification, both the employer and the provider share liability for the portion of the error the provider was aware of. If the provider did not have constructive knowledge, the employer is solely responsible for any resulting tax liability, including interest and penalties.
Supporters argue
Supporters argue that this provision brings fairness and clarity to liability, ensuring that professional payroll providers who are aware of errors bear some responsibility, rather than leaving employers solely exposed. It incentivizes providers to maintain high standards of diligence and accuracy.
Critics contend
Critics might contend that introducing a subjective standard like 'constructive knowledge' could complicate tax enforcement and lead to disputes, potentially making it harder for the IRS to collect taxes efficiently. They may also argue it could reduce the incentive for employers to meticulously review their own certifications.
Tradeoffs
The provision balances the desire to protect employers from negligent third-party providers against the administrative challenges of proving 'constructive knowledge' and the fundamental responsibility of employers for their tax obligations.
Section 1, adding new IRC Section 3513(f)
Safe Harbor for Constructive Knowledge Regarding Payroll Tax Credits
This provision defines 'constructive knowledge' generally as knowing or having reason to know of an error. However, it then creates a specific 'safe harbor' for third-party payors concerning payroll tax credits. Under this safe harbor, a payor is explicitly deemed *not* to have constructive knowledge of an error if they accurately reported the credit based on the employer's certification that they were entitled to it, and the payor verified the aggregate wages used by the employer to calculate the credit amount.
Section 1, adding new IRC Section 3513(d)
Protection Against Collateral Audits
This provision prohibits the Internal Revenue Service (IRS) from delaying the processing of payroll tax credits for an employer or initiating an audit or examination of that employer *solely* because their third-party payor filed an erroneous tax return in reliance on a certification from *another* employer. In essence, an employer should not be penalized or investigated simply because their payroll provider made a mistake for a different client.
The bill defines 'constructive knowledge' for third-party payors but then provides specific conditions under which a payor is *deemed not to have* constructive knowledge regarding payroll tax credits. These conditions are: the employer certifies entitlement to the credit, the payor accurately reports based on that certification, and the payor verifies the aggregate wages used for the credit amount.
Section 1, adding new IRC Section 3513(f)
Why it matters:This is standard legislative practice to define terms and provide specific exceptions or safe harbors within the definitions section. It's crucial for operational clarity for the affected industry, ensuring they understand their precise responsibilities and protections.
Case for: This safe harbor provides essential clarity and a predictable framework for third-party payroll providers, reducing their risk exposure for errors that are fundamentally the employer's responsibility (like eligibility for a credit). This encourages their services, which benefit many small and medium businesses by simplifying payroll management.
Case against: Critics might argue that by limiting the scope of 'constructive knowledge' so specifically for payroll tax credits, it could allow third-party payors to avoid responsibility for errors they *should* have caught, especially if the employer's certification was clearly flawed beyond just wage calculation, potentially shifting more risk to employers.
Estimated impact: This provision could significantly reduce the number of cases where third-party payors are held liable for payroll tax credit errors, potentially shifting more liability back to employers or increasing the burden on the IRS to prove actual knowledge rather than 'should have known.'