Payroll Tax Audit
An IRS payroll tax audit is a process by which the Internal Revenue Service (IRS) reviews an employer’s payroll tax returns filed to ensure that all taxes have been properly calculated and reported. Receiving an IRS payroll tax audit notice can be a stressful and overwhelming experience for any employer.
The IRS may disagree if your business has workers you treat as independent contractors. The IRS can conduct a payroll tax audit and may decide that the workers are employees instead of independent contractors. Payroll tax audits usually span a three-year period, but if your business doesn’t file any employment tax returns, i.e. Form 941 then there is no statute of limitations, and the IRS could go back even further.
Losing a payroll tax audit can be financially devastating for a business. Not only are there taxes, but in most cases the IRS will impose penalties, and of course interest. Penalties can include failure to deposit (FTD) penalties under Internal Revenue Code Section 6656 which range up to 15 per cent, failure to file penalties of up to 25 per cent pursuant to Internal Revenue Code Section 6651, and accuracy related penalties under Internal Revenue Code Section 6662 of 20 per cent. Once an IRS payroll tax audit is completed the IRS will usually send the results to state payroll tax agencies such as the California Employment Development Department (EDD) which may begin its own payroll tax audit.
What triggers a payroll tax audit? In many cases our CPA have found it is a disgruntled worker. The worker may have been very happy to have a flexible schedule, and not have taxes withheld from her check, but if she runs into problems paying her self-employment taxes, she may complain to the IRS. One way of complaining is by filing Form SS-8 Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. This document seeks to have the IRS determine whether a particular person is an employee or an independent contractor. Although it can be filed by either a business, or a worker, the experience of our IRS CPA experts are that the filing of the form by a worker is a common trigger for the IRS targeting the business for a payroll tax audit.
When the IRS receives Form SS-8 from an individual it usually reaches out to the business for its input. This is not considered a payroll tax audit, but nonetheless should be taken very seriously. In some cases, our CPA have been able to head-off a full scale payroll tax audit with appropriate responses to the Form SS-8 inquiry. The Form SS-8 asks numerous questions such as: (a) How does the worker receive work assignments, (b) what types of reports are required from the worker, and (c) is the worker required to provide services personally? How does the IRS determine if your workers are independent contractors or employees?
Some business owners believe that as long as they have a written contract with their workers which states that they are independent contractors that is sufficient. Our CPA found that in practice, that is just one small piece of the puzzle. Generally, the IRS looks at a 20 factor test which is also called the “common law” test, because it is derived not from a specific statute like the Internal Revenue Code, but English common law. The 20 factor test looks at the level of control the employer exercises over the workers. In recent years the IRS has been shifting to a three-part test which categorizes the factors into three categories: Behavioral control, financial control, and the relationship of the parties. The questions in the Form SS-8 try to get at determining if the three-part test has been met.
The 20 factor test and the three part test are complicated. It is not simply a matter of counting up the number of the facts that point to independent contractor status, and employee status, and the category with the most facts wins. The IRS, and the courts weigh all of the facts and circumstances in arriving at a determination. Our CPA can help you gather the evidence needed to show the IRS that your workers are independent contractors and not employees. If the IRS does not agree, our CPA can appeal your case to the IRS Appeals Division.
Even if you cannot prove that your workers are independent contractors, almost 40 years ago Congress passed legislation to help business owners with workers who didn’t qualify as independent contractors under the traditional 20 factor test. This law is sometimes known as safe harbor relief or Act Section 530 relief. It’s called Act Section 530 relief because Congress passed it as Section 530 of the Revenue Act of 1978. Interestingly it is not part of the Internal Revenue Code, so many tax dispute representatives aren’t familiar with it at all. Our CPA are, and we can help determine if you qualify.
If you do, we can help you resolve your payroll tax dispute with the IRS. In some situations, we can do that by presenting the proper evidence to the IRS revenue agent handling your case, or by bringing your case to the Internal Revenue Service’s Appeals division.
Even if you don’t qualify for safe harbor relief or Act Section 530 relief, the IRS has a special settlement program that allows their revenue agents, and their appeals officers to settle cases for less than the full amount due even if your business has the money to pay in full. This program is known as the Classification Settlement Program, or CSP, and is available to business who meet some, but not all of the tests to qualify for Act Section 530 relief. During your payroll tax audit, or even on the appeal of your payroll tax audit our experienced tax lawyers can negotiate with the IRS on your behalf to reduce your payroll tax debt through the IRS Classification Settlement Program.
The Classification Settlement Program should not be confused with the IRS Voluntary Classification Settlement Program or VCSP. The VCSP is not available once a business has been notified of a payroll tax audit.