Litigation

IRS begins employment tax audit initiative

By John Walch

The "tax gap" is the difference between what the IRS collects and what it thinks it is owed.  In 2005, the IRS estimated the gap was $345 billion, including approximately $60 billion in employment taxes.  To help close the gap, the IRS announced it would conduct a National Research Project (NRP), randomly auditing over 6,000 employers over the next three years.  NRP audits are used to generate baseline data that the IRS uses internally in determining what are typical numbers on a return.  As a result, the audits are very comprehensive.  The IRS is now about to begin the audits.

The NRP audits will focus on four areas: employee classification, fringe benefits, expense reimbursements and compensation paid to owners.  The classification issue (whether a worker is an independent contractor or an employee) has long been fruitful ground for the IRS due to the lack of clear standards.  Likewise, whether a distribution to an owner is a return on investment (exempt from employment taxes) or compensation for services (subject to employment taxes) is also an issue without absolute answers.  The other two audit areas are documentation issues -- whether a benefit plan conforms to the tax code, and whether it is operated correctly.  Of course, in auditing these issues the IRS will be looking at correctness and timeliness of tax reporting and deposits.  Although they are not the focus areas, it is common for the IRS to discover errors and inconsistencies.

The initiative is a reminder that the IRS is interested in how a business pays its employees and owners.  Since the classification and compensation issues involve grey areas, it may be worth while to discuss them with counsel now instead of the IRS later.

Full post as published by Northwest Business Litigation Blog on February 09, 2010 (boomark / email).