written by Amy Shewmaker
The likelihood that your business will be involved in a tax audit has increased in an effort by the IRS to attempt to reduce the “tax gap” of uncollected revenues. The IRS has estimated that they have lost approximately $54 billion from employment tax noncompliance, with FICA being under-reported by $14 billion, self-employment tax under-reported by $39 billion, and unemployment tax under-reported by $1 billion.
The IRS has been conducting audit surveys in order to provide them with a better picture of the areas of noncompliance and which taxpayers are most likely not in compliance. Based on these audits, they have narrowed their focus on four areas of concern: backup withholding, tip reporting, worker classification, and fringe benefit reporting.
Backup withholding was the number one problem uncovered in the audits. The IRS requires backup withholding on income (such as interest, dividends, and nonemployee compensation) reported on a Form 1099 that is not typically subject to withholding. Failure to provide a taxpayer identification number (TIN) on the Form 1099, an incorrect TIN, or a TIN that does not match the name on the form can trigger a withholding. A taxpayer’s failure to report the income can also trigger a backup withholding.
Tip reporting is a major concern of the IRS, and it has become a problem for smaller businesses that are not aware of noncompliance issues. The IRS has been focusing on educating employers, and is not auditing employment tax returns filed before 2014. One of the most common issues the IRS is finding is the failure to differentiate between service charges and tips. A payment that is automatically added to a bill may be a service charge. A service charge is characterized as Social Security wages, rather than Social Security tips. The distinction is important, because employers can claim a Social Security credit for FICA taxes on tips that exceed the minimum wage, but cannot claim a credit for taxes paid on service charges.
To avoid FICA, unemployment, and federal withholding taxes, some employers classify employees as contract labor. This has been a concern for the IRS for quite some time. They are regularly conducts audits to reclassify contractors as employees and have developed two programs to assist in the reclassification. The Classification Settlement Program (CSP) is for companies who are currently under and audit, and the Voluntary Classification Settlement Program (VCSP) is for companies who are not currently being audited. Companies that agree to treat workers as employees generally pay reduced taxes and may get audit protection for prior years.
Fringe benefit reporting
Fringe benefits can be cash or noncash benefits provided in addition to regular wages. These benefits are taxable and must be included in an employee’s income, unless the Tax Code specifically excludes the benefit. Also, if the recipient of the fringe benefit is an employee, the value of the benefit is additional compensation subject to employment taxes.
With the current budget crisis, the IRS will begin to use data collected in their audit surveys to monitor employment tax noncompliance more closely, as they have become aware of the large amount of uncollected revenue they are missing. To avoid an employment tax audit, please review how your tax compliance measures up to the new degrees of scrutiny.
If you have any questions about these areas of noncompliance, please contact us today 417-881-0145.