March 9, 2010
March 9, 2010
IRS Begins Employment Tax/Fringe Benefit Plan Audit Focus
Barran Liebman LLP
Oregon Law Firm,
Each year, March signals the start of Spring and Daylight Savings Time. This year, however, March brings the start of yet another important landmark: the Internal Revenue Service’s long-foreshadowed employment tax audit program, known officially as the Payroll Tax Audit Initiative. The Initiative will randomly select employers for audits of their compliance with employment tax laws, with a focus on:
• Fringe Benefits
• Employee Reimbursements
• Executive Compensation Reasonableness
• Classification of workers as Employees or Independent
Obviously, employers who are randomly selected for the audit will need to be prepared to address their employment tax practices. However, the Initiative is a worthwhile opportunity for employers who are not selected for an audit to review their payroll procedures in all of the above areas. Employers should pay special note to provisions in employee handbooks and other employer literature regarding these four targeted areas.
Employers should evaluate the fringe benefits they offer and determine whether taxes are properly withheld and income tax is imputed to employees as required. Employers commonly (and mistakenly) believe that fringe benefits are non-taxable, or fail to withhold taxes on fringe benefits. Fringe benefits include:
• Employer paid automobiles
• Awards such as gift cards
• Education Assistance Plans
• Dependent care programs
• Discounted services
• Meal and Travel reimbursements
• Corporate credit card expenses
• Leave bank programs
• Fitness programs and classes
• Personal computers and cell phones used for personal time at home
• Vacation and sick leave cash-out programs
As part of the Initiative, the IRS will focus on employee-reimbursement policies, a frequent area of confusion for employers. What are the tax consequences when employees pay business expenses out of their own pocket and receive reimbursement from the employer? Many employers assume that in this scenario, the employer simply takes a tax deduction for the expense and the employee does not report the reimbursement as income. In the absence of a written reimbursement policy, this practice is incorrect. Unless a written reimbursement policy is in place, the employer should deduct the reimbursement as compensation and withhold employment taxes reimbursement amount. On the other side of the ledger, the employee should report the reimbursement as income, and in most instances will not be allowed to deduct the business expense. If there is a written policy in place, the expenses are deductible as business expenses, not subject to FICA/FUTA and are not recognized as income by the employee.
This issue will focus on both the C Corporation distributing all profits to its owners in an attempt to have one layer of income tax and S Corporations/LLCs which pay minimum salaries to avoid taxes. Employers should review their policies if they meet either of the above fact situations.
This has long been a focus of the IRS and the Department of Labor. The IRS prefers that workers be employees, rather than independent contractors, because the employer has the obligation of paying social security and unemployment taxes for employees, but not for independent contractors. Employers should evaluate their independent contractor relationships to ensure that these individuals are not “disguised employees.”
Steps to Take
Whether you are selected for audit, or are simply planning ahead, evaluation today can save significant dollars in the future. Most of the problems an IRS audit would uncover can be solved in advance by having the proper procedures in place. The existence of proper policies relating to employee reimbursements, executive compensation, fringe benefit programs and classification of workers can save the time and expense of IRS tax exposure.
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