IRS Worker Classification Program Continues into 2011—Are You Prepared?
Legal Alerts
1.04.11
During 2010, the Internal Revenue Service ("IRS") began its National Research Program ("NRP") to conduct extensive employment tax examinations of 2,000 businesses each year for three years. The IRS has been using these NRP examinations to both thoroughly audit the targeted company and provide detailed statistical information relating to compliance, including payment of tax, substantiation of deductions, and worker classification. In 2011, the NRP is continuing into its second year with no signs of slowing down. The NRP continues to focus on a few primary areas: worker classification, employment taxes, and employee benefits. Whether or not your organization is targeted for this audit, early 2011 may be an opportune time to consider a thorough analysis of current practices as a way to identify issues that could result in liability.
1. Employment/Labor
The IRS will likely focus its attention on the misclassification of workers as independent contractors (as opposed to employees) and improperly classified "exempt" workers who should have been treated as non-exempt. The determination of both of these issues with respect to workers requires a thorough analysis of federal and state laws, judicial determinations, and federal tax laws. Employers should consider conducting an internal review of employment and payroll practices, including contracts and other supporting documentation, to ensure compliance with state and federal laws and reporting requirements. Maintaining proper and organized records will help reduce the cost and time of an IRS audit.
2. Employment Taxes
The misclassification of employees as independent contractors, or exempt as opposed to non-exempt, is very costly to the government due to the underreporting and underpayment of payroll taxes, including FICA taxes (Social Security and Medicare), unemployment taxes, and employee income taxes. In the case of workers who are claimed to be independent contractors, employers are not obligated to withhold FICA and similar payroll taxes from compensation payments to these individuals. In contrast, employers are required to withhold these taxes from wages if a worker is an "employee." If an individual/employee is misclassified as an exempt independent contractor, overtime wages that are due (including the withholding and tax issues identified above) can become a significant legal and financial issue. Individuals responsible for withholding and remitting these taxes can be held personally responsible for certain unpaid taxes. The IRS has indicated that it will focus on reducing underreporting by ensuring proper classification of workers and, if necessary, collecting unpaid taxes from responsible persons.
In addition, states may partner with the IRS during the audit process under information-sharing agreements. Michigan entered into such an agreement in 2007 to strengthen tax enforcement, including its unemployment insurance auditing.
3. Employee Benefits
Employee benefit programs are complicated, and only certain employers may maintain tax-free or pre-tax benefit plans. Independent contractors, for example, may not exclude any benefits received from compensation. Many employer-provided benefits are excluded from employees' taxable compensation, but not all. Employee benefits provided under a plan, as well as other payments or benefits provided to employees, will be scrutinized to determine if the employer properly classified and deducted those payments or benefits. The auditors are likely to focus on Section 409A and other forms of executive compensation to determine initial compliance with newly issued regulations, safe harbors, and compliance programs.
Conclusion
IRS enforcement efforts in the area of worker classification are expected to continue at high levels in 2011. The labor, tax, and employee benefit issues that arise in these types of cases can be complex, and employers are well advised to adopt a multidisciplinary defense strategy for any IRS worker classification audit.
Taxpayers with questions about classification or related matters may contact Martin Galvin at 313-568-6912, Margaret A. Hunter at 313-568-6788, or Wayne D. Roberts at 616-776-7514.
As part of our service to you, we regularly compile short reports on new and interesting developments and the issues the developments raise. Please recognize that these reports do not constitute legal advice and that we do not attempt to cover all such developments. Readers should seek specific legal advice before acting with regard to the subjects mentioned here. Rules of certain state supreme courts may consider this advertising and require us to advise you of such designation. Your comments on this newsletter, or any Dykema publication, are always welcome. © 2011 Dykema Gossett PLLC
