Newland's Business Notes

Guarding the Flock From Embezzlement    

Volume 16 Issue 4 -- July/August 2012

Faith based groups and charities generally are organizations that tend to trust individuals and be forgiving. As such, they are often victims for the proverbial wolf in sheep’s clothing. A recent case is a good example of the harm that can come to a church and school as a result of an errant accountant.

Elma was a former CPA who moved to Virginia and became a member of the Church of Ultimo Fe. There she found God, a job, and a source of funds. Elma first volunteered to be the treasurer for the church. The church had two or three employees and a related church academy with about 400 students and 50 teachers. Eventually, Elma became the head of the school, known as “the Academy.”

Elma was responsible for paying bills for both entities, preparing federal and state withholding tax returns and remitting to the taxing authorities the withholding taken from employees’ compensation. Unfortunately Elma withheld but kept the funds due to the Government. In addition to stealing the employees’ money, she did not file income tax withholding returns (Form 941).  This generated huge tax liabilities for the Academy.

Approximately 12 years passed with Elma not filing 941 tax returns. In order to avoid early detection, Elma issued W-2’s to the employees.  Possibly to avoid or delay detection, she did not file a related form (W-3)that consolidates and reports total compensation for the year. The annual W-3 form is shared by the IRS and Social Security Administration, so that employees (here the Academy’s teachers) are properly credited with Social Security earnings. Since Elma had not filed the requisite reports, when some of the teachers retired, they did not have proper credit for their Social Security earnings.

In short, the situation with Elma and Ultimo Fe was an ultimate mess.  It is common to see news stories about so and so taking money from the Girl Scouts or similar organizations. How can such problems arise and how can they be avoided? 

One of the first avoidance mechanisms to be considered should be to have a different member of the church or group (not the treasurer) do the monthly bank reconciliation.

Elma was taking the church and Academy’s money for her own purposes. In short, she was embezzling funds. If another member of the church had been balancing the checking account each month, this sort of treachery would probably have been discovered.

Individuals handling money for an organization should be screened, and a written policy for screening should be enforced.  In particular, a former professional coming from out of state may have chosen to relocate because of prior problems in his or her former state — Elma’s situation.

Another protective step would be to make sure that the federal 941 and similar state returns are filed with the IRS. Someone other than the person preparing them should look at the returns and verify if they are filed.  This could be done by getting transcripts from the IRS and/or verifying that the remittance to the IRS has in fact been made. 

Many assume that a situation like that of the Academy and Elma cannot go on for more than a year or so.  Not true.  We have seen quite a few cases where this has persisted for many years.  In this case, the IRS eventually prepared the missing returns. By then the Academy owed more than $1 million in withholding taxes and was forced to close.

There is more. When 941 taxes are not paid to the IRS, the tax code converts the amount of the unpaid withholding to a personal liability for the “responsible parties,” which we discussed in a series of our newsletters in the summer of 2004.

Elma succeeded not only in making herself liable for the unpaid withholding; she even caused the liability to be assessed against Reverend Right of Ultimo Fe. This happened because when Elma was away she asked the Reverend to sign the payroll checks.

The IRS tries to collect unpaid withholding by going after anyone who signed payroll checks, even if it is the right Reverend Right.

It is usually difficult to get someone removed from this liability, but it is sometimes possible if it can be proven that the Reverend was unaware of what was going on and did not purposely elect to pay others and ignore the withholding tax debt.

While it may be offensive to some religious leaders, it is often advisable for church organizations not to have the religious leader as signatory on payroll checking accounts. If the religious leader is not a signatory on the payroll checking account, there is usually no way he or she can become liable for unpaid withholding unless he or she is aware of the misconduct and approved or acquiesced in it.

If your organization is having problems of this sort, you may want to contact Newland & Associates for assistance.


Copyright 2012

Published by the law firm of Newland & Associates, PLC
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Call us at (703) 330-0000 for a full range of business law and tax-related services.

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