The Internal Revenue Service (IRS) has recently begun a 3-year National Research Program to randomly select and intensely audit approximately 6,000 companies to focus on employment tax issues to include review of independent contractor status, executive compensation, fringe benefits and other employment tax issues. This is a first attempt (in approximately 25 years) where the IRS National Research Program has targeted employment tax.
The goal of the IRS is to identify areas of noncompliance across industry sizes and sectors including nonprofits and governmental entities, with an ultimate goal of revenue collection.
The employment tax examination issues will include independent contractor/worker classification issues, including executives rehired as consultants, dual status employees and employee leasing arrangements.
Independent Contractors vs. Employees
Perhaps the most common area of concern of small businesses is the classification of workers as independent contractors (not employees). Independent contractor classification generally results in a decreased economic burden of the business to avoid payroll taxes and other economic costs associated with employees.
The IRS will almost always reclassify all workers as employees.The determination of employment status is generally based on 20 factor common law test (not statutorily defined).
Consequences of a Payroll Examination
There are unfortunately various consequences to taxpayers that may be asserted by the IRS. The Company may be subject to backup withholding current rate of 28%; There may be a disallowance of income tax deductions not paid pursuant to an accountable plan; There may be additional income taxes imposed upon recipients of employee benefits that are deemed to be wages or taxable income; There may be asserted negligence penalties of 20% on additional tax obligations; There may be asserted penalties for failure to provide Forms 1099 or W-2
What to Do
If selected for a payroll tax examination don't panic just get professional help. This type of examination will require the services of a specialist in dealing with the IRS; not your every day accountant. Review your current employment arrangements with your advisor and determine your degree of exposure, if any. Review the 20 factor test, see to what extent the safe harbor provisions apply and gather the necessary documentation in support of your positions.
In summary, be prepared, hire professional advisors and take the necessary steps to reduce your exposure that you haven't already.
