Contingent Workforce Solutions

October, 2009 - IRS to Audit 6,000 Companies on Employment Tax Compliance

The Internal Revenue Service (IRS) has stated that beginning in February 2010 it will begin detailed employment tax examinations of 6,000 U.S. companies chosen at random. In addition to the revenue this initiative is expected to generate, these examinations will provide statistical data for the IRS’s first National Research Program (NRP) study of employment tax compliance since 1984.

One stated objective for this audit initiative is to provide updated estimates for the extent to which the so-called “tax gap” is derived from employment tax compliance issues.  Although the initiative is not specifically limited to these areas, the IRS has indicated that these audits will focus on five primary employment tax issues: worker classification, fringe benefits, reimbursed expenses, officer compensation and non-filers.

The IRS determined the National Research Project was necessary to address a significant gap between employment taxes owed and those fully paid, a difference the IRS attributes to employer underreporting, underpayment and non-filing. A 2001, U.S. Department of Treasury estimate puts the gross employment tax gap at $345 billion and the net gap, after enforcement, at $290 billion.

One of the key areas the IRS will be auditing is proper classification of workers as either employees or independent contractors. While this topic has always been within the scope of IRS activities, it has received more attention in the last couple of years. In 2007, the IRS created a Memorandum of Understanding with state unemployment agencies to exchange information about employment tax issues, including worker misclassification. Last month, the U.S. Government Accountability Office (GAO) released a report urging the U.S. Department of Labor and the IRS to increase investigations into proper worker classification, to educate employers about proper classification, and to assess penalties against employers who misclassify workers. Colorado also passed a law this year increasing penalties for employers who misclassify workers (see September 2009, Synergy IC Spotlight Blog).

The IRS has indicated that it will select 2,000 companies per year over the next three years to be audited as part of this NRP initiative. The audit initiative will target a broad cross-section of businesses of varying size and legal form, including tax-exempt employers. The IRS has remarked that there is very little that companies can do to avoid being targeted under this audit initiative, because the companies will be selected at random. Once selected, companies should anticipate that the employment tax audits will be extremely detailed, and will very likely cover issues beyond the five specified areas of focus. 

The IRS has indicated that these audits will be conducted by approximately 200 to 300 of its most experienced agents. These agents will undergo further specialized training in connection with their role in this employment tax audit initiative. These audits will very likely involve a line-by-line review of the company's employment tax returns (IRS Form 941, "Employer's Quarterly Tax Return"). The agents are also likely to review related documents, such as the employer's income tax returns (IRS Forms 1120, 1065, 990, etc.), as well as any information returns filed (IRS Forms W-2, 1099, etc.)

The IRS has indicated that the NRP audits will likely focus on employment tax returns for the calendar years 2007 and 2008. Of course, the IRS is not limited in its ability to expand the scope of the audit either backwards or forwards into other open employment tax years, or into other categories of tax.

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