Presentation on theme: "Comprehensive Employment Tax Examinations Are Here – Are You Prepared? April 12, 2010 Adam Cohen Catherine Wilkinson Moderator: Mark Silbiger."— Presentation transcript:
Comprehensive Employment Tax Examinations Are Here – Are You Prepared? April 12, 2010 Adam Cohen Catherine Wilkinson Moderator: Mark Silbiger
2 Overview Summary of employment tax national research project Key issues Worker classification Fringe benefits Employee reimbursements Executive compensation
3 Overview Managing an employment tax audit Legislative update Severance and FICA – Quality Stores Q&A
4 Summary of Employment Tax NRP Background on the NRP August 2009 GAO report First comprehensive employment tax study since 1984 Coincides with other Administration efforts relating to worker classification Attempt to measure tax gap caused by worker classification issues – as much as $50bn Goal is to gather data, not raise revenue
5 Summary of Employment Tax NRP Scope of the NRP Focus on worker classification, fringe benefits, executive compensation, employment tax reporting/deposits Three years 6000 employers, including approximately: 2000 total per year Reportedly, 500 EOs per year Reportedly, 30-50 of 500 EOs may be government Trained approximately 200 agents
6 Summary of Employment Tax NRP Selection for NRP Random selection, all types of organizations Reportedly includes 20% large companies 3850-B letters expected to be sent in March If under CAP, not subject to NRP
7 Summary of Employment Tax NRP Audit process Focus on 941, but also corporate returns and executive 1040s Use of checksheets Likely less flexibility over scope and materiality for agents Potential use of other IRS information sources (e.g., SS-8’s)
8 Summary of Employment Tax NRP Years covered Start with 2008 If find issues, may go back to 2007, forward to 2009
9 Key Issues – Worker Classification Issue: Whether workers are properly classified as employees or independent contractors Topics : Common Law Test Frequent Issues Non-tax Consequences of Misclassification Tax Consequences of Misclassification Section 530 relief
10 Key Issues – Worker Classification Common Law Test: All of the facts and circumstances indicating the degree of control and independence must be considered. No one fact is determinative. The D.C. Circuit refined the common law test as follows: “[W]hile all the considerations at common law remain in play, an important animating principle by which to evaluate those factors in cases where some factors cut one way and some the other is whether the position presents the opportunities and risks inherent in entrepreneurialism.” FedEx Home Delivery, Inc. v. National Labor Relations Board, No. 07-1391 (D.C. Cir. Apr. 21, 2009) (emphasis added).
11 Key Issues – Worker Classification IRS Analysis Revenue Ruling 87-41 provides twenty factors for determining a worker’s proper employment classification. The IRS has refined the twenty factors to three categories: Behavioral Control Financial Control Type of Relationship
12 Key Issues – Worker Classification Behavioral Control: Does the company control, or have the right to control, what the worker does and how the worker does his or her work? Factors: Does the business provide the worker with instructions about when, where and how to do work? Does the business provide the worker with greatly detailed instructions? Does the business evaluate the worker on his or her work performance or on the end result? Does the business provide the worker with training on how to do the job?
13 Key Issues – Worker Classification Financial Control: Are the business aspects of the worker’s job controlled by the business? Factors: Does the worker have a significant investment in the equipment used for the job? Does the worker have unreimbursed expenses related to the job? Does the worker have the opportunity to make a profit or loss with respect to the job? Is the worker generally free to seek out other business opportunities in the relevant market? Is the worker guaranteed a regular, periodic wage?
14 Key Issues – Worker Classification Type of Relationship: How do the worker and the business perceive their relationship? Factors: Is there a written employment contract? Does the business grant the worker employee benefits, such as insurance, pension plans, paid vacations, sick days, and disability insurance? Is the relationship expected to continue indefinitely? Is the worker providing services that are key aspects of the business?
15 Key Issues – Worker Classification Frequent Issues Executives rehired as consultants Dual status employees Employee leasing arrangements
16 Key Issues – Worker Classification Non-tax Consequences of Misclassification Claims for entitlement to employee benefits Workers’ compensation and unemployment liabilities Subject to claims for violating state and federal labor laws
17 Key Issues – Worker Classification Tax Consequences of Misclassification If a business has no reasonable basis for treating an employee as an independent contractor, the business may be held liable for back taxes and penalties.
18 Key Issues – Worker Classification Penalties if a 1099 was filed for an improperly classified worker 100% of FICA employer should have paid 20% of FICA employees should have paid 1.5% of all wages paid misclassified workers 100% of FUTA that should have been paid
19 Key Issues – Worker Classification Penalties if a 1099 was not filed for an improperly classified worker and no employment taxes were withheld 100% of FICA employer should have paid 40% of FICA employee should have paid 3% of all wages paid the misclassified worker 100% of FUTA that should have been paid
20 Key Issues – Worker Classification Penalties for intentional disregard, assessed when the business and those associated with the business “knew or should have known” the proper classification of the worker 100% of FICA that should have paid 100% of FICA employees should have paid 20% of all wages paid to the worker 100% of FUTA that should have been paid
21 Key Issues – Worker Classification Relief from Paying Employment Taxes for Misclassified Employees: Section 530 Relief A business that misclassifies a worker may not owe employment taxes if it meets the following three requirements of Section 530 of the 1978 Revenue Act: Reasonable Basis: The business reasonably relied on judicial precedent, IRS rulings, a past IRS audit, or a long-standing practice in the relevant industry. Substantive Consistency: The business consistently treated the worker, and similar workers, as independent contractors. Reporting Consistency: The business filed all required federal tax returns consistent with the business’ treatment of the worker as an independent contractor.
22 Key Issues – Worker Classification Relief from Paying Employment Taxes for Misclassified Employees: Classification Settlement Program (CSP) The CSP provides a standard settlement agreement for instances in which the examiners determine that certain workers are misclassified. The amount of relief provided under the CSP depends on the strength of the business' Section 530 argument. In most cases, if a business has met the Section 530 reporting requirements and agrees to begin treating the workers in question as employees prospectively, a tax assessment is made for only one year (rather than for all years of the examination) based on the rates in IRC Section 3509. If a business meets the Section 530 reporting requirements and has a colorable argument that it meets the other requirements of Section 530, the tax will be reduced to 25%.
23 Key Issues – Fringe Benefits Legal framework Working condition – travel/entertainment, cars, cell phones, dues De minimis – gifts, tickets, cafeteria No additional cost Other exclusions – parking, discount Taxable fringes Withholding on taxable fringes
24 Key Issues – Fringe Benefits Legal framework All fringes taxable at FMV under Section 61 unless an exception applies Exceptions are codified in Section 132 Key issues will be: Are the requirements for exclusion under Section 132 satisfied If taxable fringe, is the right value assigned
25 Key Issues – Fringe Benefits Section 132(a)(3) – Working condition fringe Must be an item that the employee could have deducted FringeTaxableNontaxable TravelCommutingBusiness trip to a different city LodgingHotel in home cityHotel in travel city MealsRegularly provided meals (not for “employer convenience”) Meals on overnight travel
26 Key Issues – Fringe Benefits Working condition fringe - company car Business use is non-taxable Incidental personal use does not result in tax, but narrow definition Commuting is taxable Several valuation rules available
27 Key Issues – Fringe Benefits Other working condition fringes Cell phone as working condition fringe – Notice 2009-46 and subsequent IRS statements Outplacement is generally a nontaxable working condition fringe Professional dues are nontaxable working condition fringes (but not club dues even if occasional business use)
28 Key Issues – Fringe Benefits Section 132(a)(4) - de minimis No fixed dollar amount (various amounts reflected in unpublished rulings) Value must be so small that accounting is (i) impractical or (ii) unreasonable Frequency is also relevant; more frequent = less likely de minimis
29 Key Issues – Fringe Benefits De minimis fringes Regs list certain fringes as de minimis Traditional holiday gifts Occasional event tickets Copy machine usage Occasional late night taxi and meals Gift cards and cash reimbursements – never de minimis
30 Key Issues – Fringe Benefits De minimis fringes - qualified company cafeteria Revenue must equal or exceed direct operating costs Must be on or near employer premises Must be operated by employer (or contract with catering service) Certain nondiscrimination requirements apply
31 Key Issues – Fringe Benefits Section 132(a)(1) - No additional cost Employer must not incur substantial additional cost – including lost revenue and cost of labor Cannot take into account employee payment of costs Must be in employer’s line of business
32 Key Issues – Fringe Benefits Other statutory or regulatory exclusions Qualified transportation Qualified parking Employee discount Qualified moving expenses Section 74 employee achievement award Taxable fringes – e.g., club dues Valuation is a key issue FMV, not value to employee Employer cost generally not determinative
33 Key Issues – Fringe Benefits Withholding on taxable fringes Must withhold on other cash compensation, even though the fringe is non-cash Under Ann. 85-113, can deem paid on any day during calendar year or spread throughout calendar year When collect, must deposit promptly Withhold at regular rates or supplemental wage rate
34 Key Issues - Reimbursements Generally, reimbursements of business expenses are taxable and subject to withholding Reimbursements under an “accountable plan” are not taxable/subject to withholding
35 Key Issues - Reimbursements Accountable plan requirements Business connection and reasonable expense Reasonable accounting (unless below federal per diem) Excess reimbursements are repaid
36 Key Issues - Reimbursements Potential issues Reasonableness of expenses Failure to repay excess advances Adequate accounting
37 Key Issues – Executive Compensation Corporate aircraft Spouse travel Security purpose – car and driver, corporate aircraft Common executive fringes Loans 3121(v) – FICA timing Section 162(m) Section 409A/457A/457(f)
38 Key Issues – Executive Compensation Corporate Aircraft Taxable v. nontaxable Key is whether the trip is primarily for business or primarily personal Mixed purpose trips and multi-leg trips present particular challenges
39 Key Issues – Executive Compensation Corporate Aircraft Valuation FMV - charter cost SIFL value Special SIFL rules Special situations Spouses/guests Use for outside Board meetings 50% occupied seat rule
40 Key Issues – Executive Compensation Spousal travel Spouse attendance may appear to be business related, for example attending conferences, client dinners, etc. However, generally taxable unless satisfy strict business purpose standard
41 Key Issues – Executive Compensation Security exception for car and driver, corporate aircraft Lower SIFL rates, value of driver not taxable Requires comprehensive security OR security study advising lesser security measures Driver training
42 Key Issues – Executive Compensation Other common taxable fringes Club dues Financial planning Tax advice Annual physicals (though may be excluded depending on facts)
43 Key Issues – Executive Compensation Loans Below market loans generally produce taxable income equal to the interest not charged Exception for loans below $10,000 Loans that are forgiven by service or paid with guaranteed bonuses equal to loan installments may instead be treated as up-front taxable income For public companies, loans to officers are not common due to SOX issues
44 Key Issues – Executive Compensation Section 3121(v) – FICA timing Generally, deferred compensation is subject to FICA when no longer subject to substantial risk of forfeiture, even though not otherwise taxable until later Exception for severance, not applicable to restricted stock Often an issue for traditional deferred compensation, but also RSUs, SERPs, etc.
45 Key Issues – Executive Compensation Section 162(m) For public company, $1MM compensation deduction limit for CEO and top 3 (other than CFO) Very significant exception for “performance-based compensation”
46 Key Issues – Executive Compensation Section 162(m) Most issues involve failing to comply with performance-based compensation rules Stock plan approval and re-approval Performance goal establishment and adjustments Outside director issues Target payment on involuntary termination/retirement
47 Key Issues – Executive Compensation Common Section 409A compliance issues Separation from service Employment agreements Severance pay RSUs and other phantom equity
48 Key Issues – Executive Compensation Section 457A Targeted at offshore hedge fund deferred compensation Statutory language is actually much broader E.g., multinational expat with RSUs in Hong Kong or Switzerland
49 Key Issues – Executive Compensation Section 457(f) Applies to deferred compensation of tax-exempts and government entities Substantial risk of forfeiture is common issue Potential regulatory changes
50 Key Issues – Executive Compensation Audit will likely include request for executives’ Form 1040s Purpose is generally to ensure matching employer and executive reporting
51 Key Issues – Other S-Corp compensation practices TIN solicitation Back-up withholding Timeliness of deposit of withholding on equity compensation
52 Managing the Examination Conduct an internal “mock” audit Review current practices – worker classification, and tax treatment and reporting for fringe benefits, executive compensation and expense reimbursements Clean-up worker classifications Review mitigation strategies, including- Section 530 Relief Classification Settlement Program Special mitigating tax rate Early referral to Appeals
53 Managing the Examination Taxpayer’s Goals Limit scope of the examination – likely not possible if selected for NRP Facilitate expedited conclusion of the examination Document what the auditor has reviewed Develop and maintain a professional rapport However... limit verbal and written responses to what was requested
54 Managing the Examination Initial meeting Discuss scope of audit and initial IDR Request that all future requests for records be in writing and establish procedure for handling requests Identify the contact for the auditor – if outside counsel, Power of Attorney will be required Determine any special office needs – do not provide access to copier!! Locate auditor away from major centers of employee activity Make certain employees are aware of IRS presence
55 Managing the Examination Document preparation Assemble requested files and records in well-organized manner Review all requested documents to spot any potential issues Remove all attorney-client privileged documents or attorney work product Keep a log of all documents reviewed by auditor and any copies provided to the auditor
57 Legislative Update 162(m)(3) Currently the IRS interprets “covered employee” as any employee of the taxpayer if, as of the close of the taxable year, such employee is- The principal executive officer, or an individual acting in such a capacity, or One of the three highest compensated officers for the taxable year, other than the principal executive officer or the principal financial officer, who is required to be reported to shareholders under the Exchange Act. See Notice 2007-49. The compensation limits of § 162(m) do not apply if the compensation is performance-based compensation that satisfies certain requirements.
58 Legislative Update 162(m)(3) Proposals- Eliminate the exception for the Chief Financial Officer Once a covered employee, always a covered employee
59 Legislative Update Limitation of Section 530 Relief The Taxpayer Responsibility, Accountability, and Consistency Act of 2009 (H.R. 3408, 7/30/09) Generally to qualify for relief, a business would have to demonstrate Reasonable Reliance and Substantive Consistency. The Act redefines “Reasonable Reliance” as only reliance on a written determination or a concluded examination. The Act would also increase penalties and require the Secretary of the Treasury to issue an annual report on worker misclassification.
60 Legislative Update The Taxpayer Responsibility, Accountability, and Consistency Act of 2009 (continued) The Act was introduced by Rep. Jim McDermott (D-WA). A related Senate bill (S. 2882, 12/15/09) was introduced by Sen. John Kerry (D-MA). The Act would apply prospectively to services rendered more than one year after the date the act is enacted.
61 Legislative Update Worker Classification Initiatives The President’s Proposed Budget for 2011 (issued 2/1/10) Measures to Reduce the Tax Gap The budget includes measures to help reduce the tax gap, including clarified standards for classification of workers as employees or independent contractors and clarifying when employee leasing companies can be held liable for their clients' federal employment taxes.
62 Legislative Update The President’s Proposed Budget for 2011 (continued) Department of Labor Budget The U.S. Department of Labor budget includes a request of $10.96 million for the Employment and Training Administration, and $12 million for the Wage and Hour Division. These funds would support a new multi-agency initiative to strengthen and coordinate federal and state efforts to address employer misclassification of workers. The initiative includes increased information sharing, targeted audits in high-risk industry sectors, the addition of 100 new enforcement personnel, and competitive grants to boost state incentives and capacity to address this problem. The Department of Labor initiatives are expected to increase Treasury receipts by more than $7 billion over 10 years.
63 Legislative Update Fringe Benefit Initiatives Bipartisan Tax Fairness & Simplification Act of 2010 (S.3018, 2/23/2010) The Act would repeal the exclusions for- Benefits under cafeteria plans Employee awards Premiums on group term life insurance, accident and disability insurance No-additional-cost service benefits Qualified employee discount benefits Working condition fringe benefits De minimis fringe benefits Qualified moving expense reimbursements Qualified retirement planning services Qualified military base realignment and closure fringe benefits
64 Legislative Update Bipartisan Tax Fairness & Simplification Act of 2010 (continued) The Act retains the exclusion of qualified transportation fringe benefits from gross income. The Act was introduced by Sens. Wyden (D-OR) and Gregg (R-NH).
65 Legislative Update Cell Phone Fringe Benefit IRS Commissioner Douglas Shulman has stated that he is “quite hopeful” Congress will enact legislation in 2010 to exclude personal use of employer-provided cell phones from taxation.
66 Legislative Update Corporate Information Reporting Initiative The President’s health care proposal, released February 22, 2010, includes provisions for expanding corporate information reporting requirements.
67 Legislative Update Payroll Tax Initiative Hiring Incentives to Restore Employment (HIRE) Act (Pub. L. 111-92) The act includes a payroll tax exemption for businesses from Social Security payroll taxes through December for every worker hired in 2010 who has been unemployed for at least 60 days. The act was signed into law March 18, 2010. The provision applies to wages paid after March 18, 2010.
68 Severance and FICA Section 3402(o) creates ambiguity as to whether typical severance payments are excluded from FICA IRS position – severance pay generally subject to FICA despite section 3402(o) implications Previously, Court of Claims ruled for taxpayer, Federal Circuit overturned and held for IRS
69 Severance and FICA Quality Stores – MI District Court concluded severance pay is excluded from FICA Employer can make protective refund claim, but at some point need to perfect by seeking employee consent Potential audit issue