Westchester County Home News: Bad news, IRS needs to do some research. . .on YOU.

John Tuzynski, chief of employment tax in the IRS Small-Business/Self-Employed division, made an announcement during the annual American Payroll Association (can you imagine the parties these guys throw?) meeting that the IRS was going to start a new research project.

The IRS is of the belief that there is an employment tax gap of about 15 billion dollars. In order to properly understand why they are losing 15 billion, Mr. Tuzynski announced they are going to research (audit) over 6,000 U.S. companies strictly on their employment tax issues.

As a sign that the IRS doesn’t want to be overly intrusive on the operations of the entities that they plan on researching, Mr. Tuzynski also said that before sitting down with the businesses for the audit, the IRS plans to review the businesses 941s and 1099s using “outside research”. That’s probably a euphemism for saying they are going to do all sorts of data mining and only select those companies they think they can squeeze a lot of money out of.

Additionally, the IRS is training almost 200 examiners for this task, some of whom are newbies. Keep in mind this is a research project of the IRS, not just a standard audit. That means they are going to go line by line and ask for any and all back up material you have on the issue.

Can you think of a worse nightmare? Some exuberant new hire who sees zebras instead of striped horses is going to have the power to assess your company thousands, if not hundreds of thousands in penalties and fines. This brings up an interesting side issue. You are going to pay to train these newbies. No doubt when you receive your invitation from the IRS to participate in this research project, you are going to hire an adviser to help you through it, and that advisor is probably going to charge you a few hundred dollars an hour. Now when the newbie makes some wild accusation, your adviser is then going to provide an education to the IRS new hires.

There is absolutely no doubt that a major target of this research project is going to be members of S corporations. While I’m sure none of our fine readers do this, many people pay little or no salary out of their S corporation and instead max out their dividend distributions so as to minimize the amount of employment taxes they have to pay.

Got bad news for you.

Another big surprise is going to be a new section of the code that went live in 08. It said that businesses jointly owned by husbands and wives could be reported on their schedule Cs instead of using partnership returns. The challenge is this code section could very well turn income that is not normally subject to employment taxes into income that is subject to employment taxes.

Got an LLC? Thought the income generated from the LLC isn’t subject to employment taxes? I think there is going to be a rude awakening here as well. Especially for real estate investors who flipped a lot of property, it will be easy for the IRS to make a determination that you were a “dealer” in real estate. If that happens, you are going to owe a lot in back employment taxes, with the ancillary benefit of any 1031 transactions you did being closely scrutinized.

Another big issue is independent contractors. A lot of companies start off using people as independent contractors, then decide they like it so much they never make the switch to making the workers employees. Then the IRS audits the company and assesses massive penalties, back taxes, and interest because the IRS feels the workers were employees and not independent contractors. In many cases, the back taxes are the least of the employers worries as now the department of Labor is going to hop in the picture and tell the employer that since the workers have been determined to be employees, the company was supposed to have provided the “employees” with access to retirement plans, health insurance, and other benefit plans. I won’t even get started with wage and hour law ramifications.

In 2008 alone there were close to 350,000 federal lawsuits filed with labor issues.

How do you get proactive on this issue?

Make sure you are paying yourself a reasonable salary for the efforts you put forth for your business.
A tax attorney buddy of mine says a good starting point here is to go to the Bureau of Labor Statistics website and make sure your salary is within the guidelines for your business classification and years of experience. This is typically what the IRS is going to be looking for.
Make sure all your records are in order. Revenue Agents are “graded” on how fast they can move a file. The easier you make things for them, the easier they will make them for you.
If it is a close call between a worker being an employee or an independent contractor you are going to lose. Forget a list of 20 factors if you have the ability to “control” the worker, the IRS is going to consider them an employee. The sooner you make that change the better off you will be.

Many of you may grumble about big government and be mad that they have the right to intrude into your business affairs, but I have one bit of advice for you: Get over it.

Accept reality. The IRS can make your life a living hell if you do not have your business operating in the manner they desire. While we can all cuss and grumble about it not being fair, it is going to cost you a lot in both time and energy to fight them.

The auditors are being trained and notices are going out in February, so make sure you’re prepared as well.