Employment taxes under fire

Many IRS audits focus on the employee vs. independent contractor issues.

The government’s own figures indicate that the payroll tax and self-employment tax “gap,” the difference between taxes owned and those actually paid, amounts to more than $200 billion annually.

One result: With little public fanfare and no advance warning, the Internal Revenue Service has begun a National Research Project (NRP) to collect data that will allow the IRS to understand the compliance characteristics of employment tax filers.

The information provided is expected to allow the IRS to hone in on those areas where mistakes are most likely to occur, and focus their attention to those most likely to have erred or cheated. They will also use the study results to issue new guidelines and/or regulations and, incidentally increasing tax, interest and penalty revenue.
There is no way to avoid the random employment tax audits of the NRP, there are guidelines and strategies that can help every nursery business owne correct employment tax mistakes and avoid potential trouble spots.

NRP steps
The NRP will randomly select 2,000 small, large and self-employed taxpayers from every geographic region, and examine their employment tax returns each year for the next three years – as well as their routine, less targeted audits.

Like a tsunami, the IRS will not be discriminatory regarding the taxpayers it engulfs. The audits will occur in every geographic region of the country and will target both large and small taxpayers. Whether publicly traded or privately owned, large or small, in the red or in the black, for-profit or nonprofit, public sector or private sector, all are and will be potential targets.

For example, the IRS has indicated that 330 governmental entities will be audited during this process.

The notice received by selected employers will describe the extremely detailed NRP process, a process that includes face-to-face meetings with IRS auditors and line-by-line reviews of the employer’s Form 941’s and income tax returns. The examinations will reportedly focus on the following issues:

• Worker misclassification (labeling employees as independent contractors or vice versa).
• Fringe benefits.
• Owner/officer compensation.
• Review of 1099s with either no taxpayer identification number (TIN), or TIN/name mismatches.

Classification
According to recent reports, approximately 30 percent of all IRS audits currently focus on the employee vs. independent contractor issue. The IRS frequently delves deep into many personal income tax returns that may include only Form 1099 source income.

Although re-classification of a worker most often occurs after an audit, either workers or employer can ask the IRS to determine whether the worker is an employee or a nonemployee for federal employment tax purposes. When an independent contractor/employee issue is resolved amicably, the tax laws provide a special, lower federal employment tax rates for prior years in which workers have been re-classified as employees.

The tax law prescribes reduced tax rates for misclassified workers to increase tax compliance. The law reduces an employer’s federal income tax withholding liability from the amount the employer was required to withhold to 1.5 percent of the employee’s wages for federal income tax withholding. The law also reduces an employer’s liability for the employee’s portion of FICA taxes to 20-percent of the normal amount.


Fringe benefits
Offering fringe benefits generally entitles the nursery to a tax deduction. Receipt of many types of fringe benefits is tax-free to the recipient – sometimes. Enter the complication of employment taxes. If a fringe benefit plan discriminates in some manner such as rewarding only the operation’s owners or key employees, the fringe benefit may in reality be “compensation.” And compensation in most forms means the payment is subject to employment taxes.

While many non-cash benefits including no additional-cost services such as working-condition fringe benefits (a company car for business purposes) or so-called “de minimis” fringe benefits are usually deductible by the nursery and free to the recipient, the complex and confusing rules often result in complications.

Dividends
The IRS frequently second-guesses business taxpayers, particularly closely-held businesses, when it comes to labeling the compensation of the operation’s owner or shareholder who also works in the business. Payment in the form of a dividend don’t require withholding of payroll taxes, nor do those payments qualify the business for a tax deduction. Dividends are, after all, a non-deductible distribution of profits.

Dividends are a common strategy for distributing the operation’s profits, and are subject to a double tax. First, the nursery or growing business pays taxes on its profits and, when those profits are distributed in the form of dividends the shareholder pays taxes on the dividend at his or her individual tax rate.

The conundrum: would the shareholder/officer be better off receiving a profit distribution in the form of a dividend or would the business be better off paying the shareholder compensation (and the accompanying payroll taxes) which the business could claim a tax deduction for?

The IRS is empowered to render a decision whether the amounts paid were dividends or compensation. The IRS can also decide whether the amount of officer/shareholder compensation is “reasonable.” Imagine the arguments that generates.

Trust fund penalty tax
One of the nastiest and most feared taxes currently imposed is the “Trust Fund Penalty Tax,” a whopping 100 percent penalty on payroll taxes not withheld from a nursery’s employees, and/or not forwarded to the federal government. The fear stems from the IRS’s authority to assess the penalty on all “responsible parties,” a label that can include the owners, shareholders, partners, members, managers and officers in a nursery.

Generally, there are two major tests used by the IRS to determine if someone is subject to the Trust Fund Recovery Penalty: (1) whether the party against whom the penalty is proposed had the duty to account for, collect, hand over trust fund taxes; and (2) whether he or she willfully failed to perform this duty.

Unpaid payroll taxes
The Government Accountability Office, Congress’s watchdog, reported that last year 1.6 million businesses owed more than $58 billion in unpaid payroll taxes.  On the other side of the coin, an audit recently conducted by the Treasury Inspector General for Tax Administration (TIGTA) revealed that more than $131 million in employment taxes could be lost to the U.S. government over the next five years through the improper use of just one IRS employment tax form, Form 8919, Uncollected Social Security and Medicare Tax on Wages.

“The IRS has sever