IRS Announces Extensive Employment Tax Audits; Is your contractor really an employee?

As you can imagine, with the economy still reeling and tax collections dropping the importance of the governments' oversight of our system of taxes becomes ever more critical. From both the federal and state levels we continue to read about new and improved compliance measures being put in place. Take one of the recent announcements at the end of 2009 from the IRS as an example.

The IRS has announced it will conduct intensive employment tax audits under its National Research Program (NRP) starting in 2010. This is a multi-year program with random audits scheduled to begin in February 2010. The IRS has said it will audit U.S. companies under this program. The NRP is a study and data collection project that helps the IRS update its noncompliance estimates and update its computer-based audit programs. "Normal" audits do not yield as valuable compliance data as random audits because the IRS, in normal audits, is intentionally targeting the taxpayers they believe have noncompliance problems. NRP audits on the other hand, are random to allow the IRS to statistically measure the total amount of noncompliance in a specific area. The IRS then uses this data to update its computers and estimates of the tax gap—the difference between total taxes owed and the amount actually paid by taxpayers.

The NRP audits are also much more intense and less targeted than a typical audit. The NRP audits allow the IRS to identify where the compliance problems lie in a specific population and to better target tax returns for audit in the future.

The goal of the employment tax audit program is to gather information in five categories:

  1. Worker classification
  2. Fringe benefits
  3. Non-filers
  4. Reimbursed expenses, and
  5. Officer/owner compensation

Various government agencies have recommended that the NRP be implemented for employment taxes to study and access the impact of worker misclassification on the employment tax gap, which has become a high priority of the government.  And why shouldn't it be. At stake with worker classification issues are tremendous potential uncollected taxes for Social Security, Medicare and income taxes since much of the miss-classification is what makes up the underground -- and off the tax rolls -- economy.

The administration has been quiet thus far on the issue of worker classification, but President Barack Obama was a supporter of reform efforts while in the Senate. If Congress enacts a health care reform bill with a “pay-or-play” provision for employers, it could put even more pressure on the worker classification rules.

The moral of the story is simple. Over the past few months, the IRS has provided insights into some of the new initiatives that it will focus on during 2010 and beyond. In connection with these initiatives, the IRS has been hiring and training many new agents. Make sure you keep great records, report your employees as employees and not as independent contractors and be prepared to support any position you tax on your employment tax returns.  Oh, and don't be surprised if the IRS comes calling.

Want to see where you stand and what your exposure may be as it relates to whether or not your contractors are really employees? Of course the easiest thing to do is give us a call but you can have some real fun taking a look that the IRS' own training manual for auditing this issue. You can download a copy by clicking here.

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