Napier & Company, LCC

IRS Employment Tax Audits

The IRS announced on September 23, 2009 a program to increase the number of employment tax audits. Starting in February 2010, and continuing for three years, the IRS is planning random audits of employment tax returns for 6,000 employers. The returns to be reviewed will be from 2006 to 2008. Various sizes and types of employers will be audited.
The IRS plans on focusing on four areas:

• Worker classification as an employee or independent contractor. There is a 20 factor test used by the IRS to determine worker classification status. The IRS’s focus will be looking for the misclassification of a worker as an independent contractor.

• Fringe benefits provided to employees. An employer can provide specific fringe benefits not taxable to employees. The IRS’s focus will be to determine if fringe benefits should be taxable to an employee as compensation.

• Reimbursed employee business expenses. The employer takes a deduction for the reimbursement which is not considered compensation to the employee. The IRS’s focus is to review whether the employer has and complies with the requirements of an Accountable Plan. The Accountable Plan requires the employee expense to be incurred while working as an employee, substantiation of the expenses and for the employee to return any amounts in excess of the substantiated expenses.

• Compensation paid to corporate officers must be reasonable. The IRS’s focus will be to review the amount of compensation paid to officers for excessive compensation to reduce profits and excessive compensation which should be treated as dividends.
To prepare for an employment tax audit, review your Company’s practices in the four areas the IRS is focusing on. Also review employment tax returns and supporting documentation and determine if there are inconsistencies in reported compensation amounts between the income tax returns and the employment tax returns.
If you have questions on how you are classifying your employees or the payments to them, please feel free to give our office a call.