Marco Normativo/Legal

The Internal Revenue Code refers to the U.S. Code: Title 26, which is divided into 11 Subtitles (A to K). There also are rulings and regulations associated with every subtitle further complicating enforcement, compliance, and filing of taxes. In addition, Congress continuously changes the code. Given this context, we next review the literature related to Title 26 U.S. Code Subtitle C (employment taxes).

The employment tax literature is extensive. However, a large portion of the literature focuses on the legal interpretation and consequences of rulings and law

changes. For the purpose of the present study, legal reviews will be considered to be out of scope so that we can instead focus on empirical studies. The idea is to understand the current body of knowledge gained from empirical studies in order to understand the characteristics of this market segment and to find methods that would be most appropriate for scientific analysis. Much of the empirical employment tax literature concentrates on the tax incidence16. The tax incidence is the analysis of who ultimately has to pay any enacted taxes. This literature has focused predominately on how these types of taxes affect the labor market and employee wages, and very little tackles the issue of taxpayer compliance behavior.

IV.2.1 Employment Tax Defined

Employment tax references FUTA, self-employment, social security, and Medicare tax withheld from income. Employment tax is also referred to as trust tax. It

16 _{Tax incident is related to elasticity}

takes the name trust because employees’ contributions are held in-trust by the employer until their contributions are deposited with the IRS (Murthy, 2014). In the literature review, employment tax is also synonymous with payroll tax and these labels will used interchangeably throughout the study.

An important definition related to employment tax and this study is the assess penalty and the duly authorized individual. Publication 15 states that a recovery penalty of 100 percent may be assessed to the firm (and/or duly authorized individuals) if filings and deposits do not meet the required obligations and if he/she willfully fails to pay (IRS, 2013; Murthy, 2014). Thus the assess penalty is the interested penalty a firm (or officer) must pay when it does not meet its tax obligations. A duly authorized individual is defined as an individual or officer who oversee the collection, accounting, and payment of employment tax (IRS, 2013). This definition is important since this was the group of individuals that we solicited to participate in this study. Furthermore, these individuals are legally responsible for any liability that occurs. Last, there is a dearth of research attempting to determine why authorized individuals approve illegal tax transactions, given the possible negative legal and financial implications.

IV.2.2 Employment Tax and the Tax Incidence

In economics, the term-of-art tax incidence17 is used as a framing for who

ultimately is responsible for paying the tax. The general perception is that the individual consuming the product pays the taxes. However, that is not always the case. In terms of labor markets, the party with the highest price elasticity of labor will pay a smaller

portion of any employment tax. Past research have shown that this is more commonly “borne by labour” (pg. 189) (Hamermesh, 1979; Holmlund, 1981; Vroman, 1974).

Given employers are also subject to employment tax matching, employers may exhibit similar behaviors when facing the tax incident. Empirical evidence suggested that a sub-segment of small business – self-employed taxpayers – decreased filing compliance and decreased their payment of employment when employment taxes increased (Heim, Lurie, & Pearce, 2014).

Beyond the tax incidence and its impact on labor and wages, payroll tax dilemma occurs when a firm cannot meet its operational liabilities and it uses employment tax withholdings to pay for these liabilities (Godfrey, 2004; Mauldin & Wilder, 1997). Companies normally face a liquidity crisis during economic downturns or economic distress, such as the great recession (Grady, 2013). Grady (2013) indicates that many of these businesses continue to illegally borrow from withheld taxes for expanded periods of time, and found that the majority of those businesses will eventually fail. Bloomquist (2003a) also argues that a financial strain is one of the determinants of noncompliance for all taxpayers. One of the arguments of this study is that some of the authorized

individual will succumb to the payroll tax dilemma when confronting a liquidity crisis (or strain).

A different argument from the payroll dilemma is that individuals decide to use employment tax withholding as a short-term loan without clearly understanding the negative financial implications. Another explanation is that they are simply taking a high interest loan from the federal government. As these business owners may see it, they prefer paying their supplier and staying in business than paying the IRS and go out of

business. There are cases where taxpayers consciously (or unconsciously) make late payment. Given the IRS is unable to identify these individuals until quarter’s end, the withholdings could be used to pay other responsibilities. Then, the employers make withholding deposits at the end of the quarter, putting them back to legal standing with their federal tax withholding deposits for employment tax and extending their accounts payables.

Yet another explanation for this phenomenon could be derived from individual’s perception of the outcome. This perception could be rooted in self-positivity bias where the individual expects a positive outcome or image (Mezulis, Abramson, Hyde, & Hankin, 2004) or underestimating risks (Dengfeng & Sengupta, 2013). In other words, these business owners are unable to see how their decision will lead them or their business to failure in the long run.