About 6,000 Companies to Undergo IRS Audit on Employment Tax Compliance

About 6,000 companies will undergo audit to be conducted by the Internal Revenue Service (“IRS”) for the purpose of verifying whether they remitted the proper employment taxes to cover Social Security (“SS”) and Medicare benefits, according to a Bloomberg report (See http://www.bloomberg.com/apps/news?pid=20601103&sid=anpR2t09GIeU).

This report was a follow up to an earlier statement issued by John Tuzynski, the IRS’s chief of employment tax issues late in October 2008. At that time, Tuzynski declared “a nice increase” in the number of employment tax cases over the next year (2009-2010). This will be a major focus for the IRS, and the agency has entered into data-sharing agreements with a number of state tax departments. (See http://www.heartland.org/publications/budget%20tax/article/23886/IRS_Promises_to_Get_More_Aggressive_in_2009.html).

In that regard, Tuzynski stated that the IRS will provide employment tax training manuals to the states, train state tax examiners in these issues, and provide leads to states on noncompliant businesses and information on cash payments made by employers to their workers. Tuzynski promises the IRS is “extending this [agreement] out to all 50 states.”

Another new “major focus” will be on worker classification cases. These center on whether a worker is properly classified as an independent contractor or an employee. Many companies seek to save money by classifying workers as independent contractors, as it cuts employment taxes and compliance burdens. But when those workers are misclassified, the IRS imposes substantial taxes and penalties.

In an August 2009 report issued by the Government Accountability Office (“GAO”) entitled “Employee Misclassification: Improved Coordination, Outreach, and Targeting Could Better Ensure Detection and Prevention,” it was established that the national extent of employee misclassification is unknown; however, earlier and more recent, though not as comprehensive, studies suggest that it could be a significant problem with adverse consequences. For example, for tax year 1984, IRS estimated that U.S. employers misclassified a total of 3.4 million employees, resulting in an estimated revenue loss of $1.6 billion (in 1984 dollars), the GAO report stated.

The IRS enforces worker classification compliance primarily through examinations of employers but also offers settlements through which eligible employers under examination can reduce taxes they might owe if they maintain proper classification of their workers in the future.

Further, IRS provides general information on classification through its publications and fact sheets available on its web site and targets outreach efforts to tax and payroll professionals, but generally not to workers. The IRS faces challenges with these compliance efforts because of resource constraints and limits that the tax law places on the Service’s classification enforcement and education activities.

The Department of Labor (“DOL”) and IRS typically do not exchange the information they collect on misclassification, in part because of certain restrictions in the Tax Code on IRS’s ability to share tax information with federal agencies. Also, DOL agencies do not share information internally on misclassification.

GAO found that few states collaborate with DOL to address misclassification, however, the IRS and 34 states share information on misclassification-related audits, as permitted under the Tax Code.

Generally, IRS and states have found collaboration to be helpful, although some states believe information sharing practices could be improved. Some states have reported successful collaboration among their own agencies, including through task forces or joint interagency initiatives to detect misclassification. Although these initiatives are relatively recent, state officials informed GAO that they have been effective in uncovering misclassification, the GAO report said.

Most of the audits will be conducted face-to-face, Tuzynski said, although the IRS also will gather information from internal sources and the Internet.

He added that the IRS audits, to be conducted over three years, also will focus on fringe benefits such as company cars and personal use of corporate-owned vacation property, as well as the way salaries are reported for S- corporation officers.

As part of the tax compliance audit, the IRS is expanding its National Research Program (“NRP”), The NRP is an intensive study and data collection project that helps the IRS to properly screen and target non-compliant tax returns for auditing. The NRP began with investigations into individual tax returns and then moved to business and partnership returns. (See http://www.ombwatch.org/node/10361).

In addition, the NRP will include a multiyear study, with random examinations scheduled to begin in November, according to a presentation made by John Tuzynski, IRS’s chief of employment tax, at the [American Payroll Association’s] March 2009 Capital Summit.

More Updates