Beware of Business Auditing for Misclassified Workers
In our series on how to be prepared in the various aspects of Independent Contractor risks, we came across this article from a the CPA firm of Habif, Arogeti & Wynne, LLP in Atlanta.
We trust you'll find these Audit proceedures helpful.
IRS Employment Tax Audit Initiative
By Frank Ciaburri
Last fall, the IRS announced a major audit program targeting underpayment of employment taxes by companies. Over the next three years, they expect to conduct approximately 6,000 audits of randomly selected employers for employment tax compliance. A broad cross-section of businesses are targeted, including tax exempt employers. To ramp up for this initiative, the IRS has trained 200 to 300 experienced agents to handle the workload.
Starting this month, the IRS will be sending letters to employers selected for audit. Once selected, a company should expect the audits to be very detailed and time consuming. In addition, the audit may expand into other aspects of company operations.
The audits are part of the National Research Program, which is structured to gather statistical information about compliant and noncompliant employers. This information will be used to help determine whether enforcement or legislative changes will be necessary to address evasion of employment tax schemes. The goal is to test how much of an estimated $15 billion gap in employment taxes actually exists and how to close it. Of course, collecting revenue from non-compliant employers is an important aspect.
Audit Focus
The expectation is that the audits will be thorough and will address areas perceived to be issue prone:
- Worker Classification
- Fringe Benefits
- Owner/Officer/Executive compensation
- Reimbursed Expenses
- Non-Filers
The audits will begin with the examination of federal employment tax returns and in larger companies will typically impact functions other than payroll, including benefits, legal and tax.
Of the issues being examined, employer misclassification of workers as independent contractors has the greatest collection potential for the IRS, as the employer could be liable for employment taxes even if the misclassified workers have paid their employment taxes.
For fringe benefits, the audit focus will be on the proper treatment of fringe benefits and per diems as tax free rather than as compensation. For compensation of owners and other highly paid employees such as officers and executives, the IR will consider whether compensation is reasonable in amount and will include deferred compensation, stock options, and other perks.
Expense reimbursements will be reviewed for compliance with the accountable plan rules to exclude them from compensation.
How to Prepare for a Potential Audit
To make sure your company is ready for an audit, consider taking the following actions:
- Ensure that past employment tax returns and supporting records are available and have been reviewed for compliance with applicable rules. This includes reviewing past employment tax notices and ensuring that they have been resolved.
- Perform a self-audit of your company's employment tax practices and procedures, focusing on the areas the IRS would audit if your company were selected. If issues are discovered in this process, consult with tax counsel to determine the appropriate corrective action.
If Your Company is Selected for Audit
If your company is selected for audit, designate the person that will manage the audit. This may be an internal resource and/or outside tax counsel. In larger companies, an audit may be handled by the payroll and/or tax departments, as they have experience in dealing with IRS audits.
Smaller enterprises, whether they prepare their own payroll or use a payroll services provider, generally should consider having their tax counsel manage the audit, as tax counsel regularly handles IRS audits.