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IRS Screens for Payroll, Compensation and Plan Audit Candidates with New Forms, Questionnaires

Tax compliance means revenues for the federal government — that is axiomatic.  Revenue leakage through non-compliance has a multi-billion dollar effect on federal revenue. The Internal Revenue Service has become aggressive in setting its sights on several significant leaks in the system.  These areas of concern include:

• worker misclassification that causes losses in withholding and employment taxes;
• deferred compensation non-compliance that delays the taxation of compensation; and
•  401(k) plan administration non-compliance that also keeps moneys from current taxation.

To feed the federal government’s hunger for tax revenues in the face of an historic budget deficit, the IRS has developed new informational forms and questionnaires, and new cocktails of existing tools, to help it distinguish compliant employers from the non-compliant.  Employers soon may receive one or more of these new screening tools in the mail.  

Worker Misclassification Initiative

One screening tool is the combination of the Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding,” with the Form 4564, “Information Document Request.” 

The IRS identifies companies it believes should receive Form SS-8 by the Form 1099s that are issued to service providers.  The IRS uses Form SS-8 to gather information relevant to its determination of whether an individual or group of service providers is classified properly as independent contractor or employee.  This allows the IRS to decide whether to examine a company to determine whether payroll taxes are being withheld and paid.

Joint Deferred Compensation Initiative

Recently, Form SS-8 has been coupled with Form 4564, “Information Document Request” or “IDR.”  The agency has begun asking for detailed information, such as a list of all plans/arrangements that provide an employee or contractor with a legally binding right in one year to a payment of compensation in a subsequent year.  The intent of the IDR, of course, is to flush out information on compensation arrangements subject to § 409A. (Section 409A regulates tax treatment of “nonqualified deferred compensation” paid by a company to all service providers, which includes executives, general employees, board members, and some general contractors.)

An employer’s risk of audit and potential tax liability are raised significantly when the Form SS-8 is combined with the IDR. 

In January 2010, the IRS released Notice 2010-6, addressing § 409A plan document failures, the reporting of such failures to the IRS, plan failure correction and tax consequences.  The guidance in the Notice affects compensation arrangements most employers currently do not even recognize as deferred compensation plans (such as releases under the Older Workers’ Benefit Protection Act) as potentially non-compliant deferred compensation arrangements.  A company responding to a Form SS-8 and an IDR runs a significant risk of disclosing one or more potentially non-compliant deferred compensation plans that are not on the employer’s “radar screen.”

401(k) Initiative

Another investigatory tool the IRS has begun using is the 401(k) “questionnaire.”  Currently, the questionnaire is being sent to a substantial cross-section of the 401(k) plan community throughout the United States. 

The questionnaire seeks information from plan sponsors and asks sponsors to demonstrate compliance with the qualified plan laws and regulations, as well as to determine whether the plan sponsors and administrators have policies and procedures designed to assure plan compliance.  Areas of potential non-compliance identified by the IRS as focus points for 2010 are worker classification, hardship distributions, plan loans and timing of deposit of deferrals and employer matching contributions.

What Employers Should Do

Currently, no monetary penalty is imposed for failing to complete and return these information-gathering tools to the IRS. However, employers who receive one or more of these tools should:

• Decide whether or not to respond to the IRS.  If an employer is aware of significant areas of non-compliance with regard to classification of independent contractors or pension plan administration, it may decide to refrain from answering the inquiry and engage in self-correction (if IRS publications currently permit self-correction) prior to being notified of an audit.
• If an employer decides to respond to the IRS inquiries, review the requests to ascertain what areas of non-compliance the IRS is trying to identify and the tax or other liability exposures that might arise from non-compliance.  An employer should consider whether the investigation that would be necessary to respond to the requests should be conducted with the assistance, and under the supervision, of counsel. 
• If an investigation prompted by IRS questions uncovers areas of non-compliance, the employer should determine whether IRS published guidance provide opportunities for self-correction or voluntary correction with disclosure of the compliance failure to the IRS and a formal issue resolution.  Often, correction of compliance failures prior to audit results in substantial savings in tax, penalties and interest.  This is particularly true for deferred compensation arrangements.  In its recently published Notice, the IRS provided employers until December 31, 2010, to engage in self-correction of many types of compliance failures.

Jackson Lewis attorneys have significant knowledge and experience in the areas of worker classification, deferred compensation and employee plan compliance.

IRS Circular 230 disclosure: Any tax advice contained in this article  (including any attachments or enclosures) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this article. (The foregoing disclaimer has been affixed because of U.S. Treasury regulations governing tax practitioners.)