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IRS to Launch Four Employment Tax Initiatives

The Internal Revenue Service will begin its first Employment Tax National Research Project since 1984.  This study will involve the audit of 6,000 companies and will be completed within three years.  IRS Chief of Employment Tax Operations, John Tuzynski, has announced that the Service will be focusing on four employment tax compliance initiatives in 2010: 1) worker classification; 2) tip reporting compensation; 3) officer compensation; and 4) fringe benefits.

Worker Classification

The IRS will focus on whether a worker is properly classified as an independent contractor or an employee.  In 1984, the IRS estimated that U.S. employers misclassified 3.4 million employees, resulting in a revenue loss of approximately $1.6 billion to the government.  The IRS is concerned about how this number may have increased since then and the tax revenue lost due to misclassification.

Tip Reporting

According to the IRS, voluntary compliance is important in this area.  The Service hopes that employers in the food and beverage industry will review the Attributed Tip Income Program (ATIP) and take advantage of its benefits.

Officer Compensation

The third initiative relates to the compensation of officers in S Corporations.  The concern is that S Corporations are skirting their share of employment taxes by under-reporting officer/owner compensation.

Fringe Benefits

Finally, the IRS will be focusing on fringe benefits, such as company cars, frequent flyer miles for travel, club memberships, employee tool and equipment expenses and personal use of corporate-owned vacation property.

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Unfortunately, there are no bright-line tests for determining employee status.  While violations discovered in an IRS classification audit can bring penalties, various tax law provisions and IRS programs that mitigate the amount of federal tax penalties that can be imposed for misclassification.  Thus, any federal tax penalties often may be significantly less than the penalties imposed for violations of other employment laws.  However, a determination for federal employment tax purposes is not binding for purposes of applying other Federal and State statutes and an individual may be classified as an “employee” under some statutes and an “independent contractor” under others.  Employers should review their independent contractor classifications under the federal employment tax rules as well as other employment law statutes that govern these issues.  Jackson Lewis attorneys in the Employee Benefits practice group are available to discuss a preventive review of worker classification issues.