Employment Tax Compliance: Employee Fringe Benefits Investigated

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In November 2009, the IRS started a new National Research Program Initiative (the

Initiative): an industry wide specific random audit of employment taxes for 6,000 entities to encompass the course of the next thirty six months. The scope of the Initiative is dual in nature: First: assess systemic employment tax compliance: and second: collect assessments from delinquent employers.

With tax revenues decreasing from the down economy, the U.S. Treasury Department is increasing its efforts to close the tax gap the difference between the total tax liabilities and taxes paid to the IRS. Auditing employment taxes is seen by the IRS as a crucial means of closing the tax gap. For tax year 2001 for example, the gross tax gap was estimated by the IRS at around $345 billion, with underreporting of employment taxes accounting for around 17% of the tax gap.

The IRS will audit companies to ensure that Federal withholding taxes are deducted and paid over to the government from employees wages for Social Security and Medicare as well as Federal Unemployment taxes. An employer found to be in noncompliance could face harsh civil penalties and interest on unpaid taxes. These fines could have a particularly severe impact on small business owners.

The IRS has prioritized four areas to focus their auditing efforts under the Initiative, including:

Worker Classification: i.e. whether an employer properly classifies an employee as an employee or independent contractor for tax purposes. Determining which depends on the behavioral, financial and type of relationship the company has with the person performing the work.

Employee Fringe Benefits: A fringe benefit is a form of pay for the performance of services. i.e. benefits such as insurance coverage, company car or child care, etc. that are provided by employers tax free to employees but not to independent contractors.

Reimbursed Business Expenses: e.g. reimbursement for taking a client to lunch, purchasing office supplies: which requires a written business expense plan. I.E. You must have paid or incurred expenses that are deductible while performing services as an employee. You must adequately account to your employer for these expenses within a reasonable time period, and you must return any excess reimbursement or allowance within a reasonable time period.

Compensation of Owners who are also employees of the company, whereby unpaid taxes may result in personal liability for the employer.

Since the employment tax audits Initiative has begun, it has been reported that the IRS has already started the process of selecting businesses for audit of their employment taxes. Noncompliance with employment tax law can result in severe repercussions for employers. To ensure that procedures are in place to meet with compliance of applicable tax law can save time, money and distress in the event of an audit.

For example, the Internal Revenue Code requires each employer to properly categorize their Worker classification in order to not only make sure they are in compliance with the tax laws but also be able govern their workers appropriately . Employers should consider consulting with experienced counsel in preparation for the Initiative and in the event of an audit of their employment taxes.

by: Kevin Thorn

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