Over the past few years, the IRS has been sending a loud and clear message that employment tax compliance is at the center of their attention. Based on recent activity, it is evident that the IRS is strongly committed to reducing the tax gap, which is the amount of tax liability thought to be owed by taxpayers not paid on time. Payroll taxes account for about 70% of total federal tax revenues and the IRS feels that a large number of companies are not in compliance.
In February of 2010, the Internal Revenue Service unveiled a major audit initiative focusing on underpayment of employment taxes. This national research program was designed to investigate tax compliance issues related to:
Classification of workers as employees or independent contractors;
Tax treatment and reporting of fringe benefits as tax-free or as taxable compensation;
Reasonable executive compensation; and
Tax treatment and reporting of employee reimbursements.
Although the program ended in 2012, the efforts of the IRS are far from finished. The following is a simplified outline of what employers need to know regarding each compliance area going forward.
Classification of Workers
It is no secret that the IRS prefers to classify workers as employees. Determining who is truly an independent contractor vs. an employee, however, is not an easy task. The IRS has traditionally considered 20 common law factors (found here), but is looking to develop one substantially simplified test to be used by all Federal and State agencies. Independent contractors underreport $72 billion in federal payroll taxes. As a result, this area will continue to be greatly emphasized during IRS examinations.
Tax Treatment of Fringe Benefits
It is important to recognize the fact that there is a wide variety of benefits an employer can offer, and the tax treatment of each may be different. We will discuss these in later articles. The specific fringe benefit we would like to discuss here involves the personal use of a company owned vehicle. When you provide a vehicle to an employee, you are required to treat the value of the personal use as a taxable fringe benefit. As the employer, you must include the value of that personal use in the employee’s wages for income and employment tax purposes, and withhold and remit the applicable taxes.
Reasonableness of Executive Compensation
Although the notion of reasonable executive compensation generally entails situations regarding excessive compensation, the IRS is also focusing on the scenario which involves the underpayment of compensation to shareholder-employees of S corporations. These individuals could potentially be avoiding employment taxes by receiving distributions in place of compensation for services.
Tax Treatment of Employee Reimbursements
As stated previously, certain fringe benefits are exempt from taxation. In order for employee reimbursements to be excluded from gross income, they must be under an accountable plan, meaning that reimbursed expenses must have a business connection, employees must be able to substantiate the reimbursed expenses, and any amounts received in excess of the substantiated amount must be returned to the employer. Reimbursements that do not meet these criteria are taxable and should be accounted for accordingly.
How to Minimize the Risk
Although there are no guaranteed methods to avoid being targeted for future audits, there are measures businesses can take to minimize risk. Businesses should conduct self-audits of worker classifications and other current payroll practices, specifically focusing on the areas identified by the national research program initiative detailed above. Businesses should also ensure that contracts and benefit plans reflect reality. Taxpayers may also wish to have a tax professional conduct a “simulated audit” in order to receive advice on correcting problems or deficiencies that would likely be targeted in the event of an actual IRS investigation.
Unfortunately, it is impossible to cover the many details of this issue in one article. For additional information, please do not hesitate to call or email your contact at ECS.
2013 Tax Due Dates:
June 30th –
Monthly Illinois wage report for May due (employers with 250 or more employees)
July 31st –
2nd quarter 2013 employer payroll tax returns due
August 31st –
Monthly Illinois wage report for July due (employers with 100 or more employees)
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