Controller: School district owes $20M in taxes to feds, state and city

When Mayor Nutter went on a rampage last year to publicly humiliate tax deadbeats, he was commended for being tough on those who refused to pay what they owe.

But for all his bravado, it seems the mayor neglected to call out one of the city's biggest tax evaders - the School District of Philadelphia.

The district owes the city, state and federal government millions of dollars in unpaid taxes for money paid to retired and resigned employees, according to the City Controller's Office.

The district has avoided paying $20 million in taxes on its former employees' termination pay since 2005 by depositing the cash into tax-deferred retirement accounts, from which local, state and federal insurance (FICA) taxes aren't withheld, according to the controller.

The city says the method is illegal. District officials disagree and have requested a ruling from the IRS, according to reports from the controller's office. The IRS has yet to respond, said a district source with knowledge of the matter.

If the IRS rules against the district, it is expected to pay roughly $20 million, including $12 million to the feds, $3.2 million to the city and $2.4 million to the state.

"What the School District of Philadelphia is really doing here is screwing all the governments that supply them with their money to operate," said a district source. "They're biting the hands that feed them."

The district did not respond to the Daily News' repeated requests for comment.

According to the audits, district officials made their decision based on the advice of outside legal counsel, whom they have refused to identify.

"No taxing authorities have challenged the tax treatment accorded these termination payments, and the school district has no reason to believe that any such challenge . . . would be successful," the district said in response to the controller's audits.

A spokesman for the IRS declined to comment, citing confidentiality laws, as did a spokeswoman with the state Department of Revenue.

Tilahun Afessa, director of policy for the city's Department of Revenue, didn't speak to specifics of the case, but said an employer is responsible to withhold the tax and remit the amount to the city.

"Employees' termination pay is subject to Philadelphia wage tax before any deposit is made into a 403(b) tax-deferred account or before an employee receives his or her paycheck," he said.

Deputy City Controller Harvey Rice added that no other taxpayer-supported agency audited by the office uses this method.

The practice began in July 2005, when Michael Harris, chief financial officer under former chief executive Paul Vallas, redefined termination pay - the accrued and unpaid amounts of vacation, personal and sick leave for a resigning or retiring employee.

Instead of paying taxable money owed to a resigning or retiring worker in cash, officials began depositing the money into a 403(b) account, which doesn't withhold local, state or FICA taxes, the source said. Money withdrawn from that retirement plan is subject only to federal income tax.

The former employees have received most of the benefit from the setup, while the district has saved itself about $8 million, said the source, who didn't want to be identified for fear of reprisal.

"There's incentives for the employees," Rice said of the pay method. "We're still trying to find the incentive for the district."

Afessa said employers are motivated by one of two reasons to use this method. One is that an employer may not be aware of the law. Another reason, he added, is less noble.

"They don't think anybody's going to catch them," he said. "Whoever the employer is, it's that employer's responsibility."