IRS Payroll Tax Audit & Misclassification of Workers

IRS has employment tax examiners who conduct payroll tax audits mostly to identify and assess for worker misclassification.

What does worker misclassification mean? It means that employers report to the Internal Revenue Service and Employment Development Department workers as independent contractors, vendors, or other types of employment instead of Employees.

How does the reporting of workers as independent contractors affect employers instead of reporting them as employees?

The employers get a tax break when they incorrectly report workers as independent contractors for the employer does not have to pay its share of social security taxes, unemployment taxes and state employer taxes as required.

For IRS purposes, no social security tax of 6.2% per employee and no unemployment taxes for each employee up to the first $7,000.00 in wages. It can be a significant amount of unpaid taxes. Especially, when workers should be classified and reported as employees.

The IRS computer system via an algorithm, a whistle-blower, an ex-worker who claims unemployment benefits for which no unemployment tax payments are being paid or have been paid by the alleged employer, prior payroll audits by state tax agency and other methods are utilized to open an investigation for unreported/misclassified payroll audits.

Companies who face payroll tax audits should hire a tax professional who is knowledgeable in payroll tax audits. There are various types of audits for payroll.

First there are payroll audits for wages reported on payroll tax returns mismatching with wage and income statements filed with the IRS and Social Security Administration.

Then, there are adjustments to payroll taxes due to miscalculations on the original payroll tax returns filed. Amended payroll tax returns which can cause problems in the amounts entered on the account transcripts.

Reporting commissions on company tax returns for which IRS identifies as significant to merit a payroll audit due to possible misclassification of workers. There are many companies such as Real Estate Brokerages that can report high commissions which are legally authorized to report the earnings of real estate agents and others as independent contractor earnings on Form 1099 Miscellaneous Income.

There are several types of workers that the government identifies.

• Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.

• People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they offer their services to the public are generally independent contractors. If an employer-employee relationship exists (regardless of what the relationship is called), you are not an independent contractor

• If workers are independent contractors under the common law rules, such workers may nevertheless be treated as employees by statute (statutory employees) for certain employment tax purposes if they fall within any one of the following four categories and meet the three conditions described under Social Security and Medicare taxes, below.

1. A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery products; or who picks up and delivers laundry or dry cleaning, if the driver is your agent or is paid on commission.

2. A full-time life insurance sales agent whose principal business activity is selling life insurance or annuity contracts, or both, primarily for one life insurance company.

3. An individual who works at home on materials or goods that you supply and that must be returned to you or to a person you name, if you also furnish specifications for the work to be done.

4. A full-time traveling or city salesperson who works on your behalf and turns in orders to you from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments. The goods sold must be merchandise for resale or supplies for use in the buyer’s business operation. The work performed for you must be the salesperson's principal business activity.

• There are three categories of statutory non-employees: direct sellers, licensed real estate agents and certain companion sitters. Direct sellers and licensed real estate agents are treated as self-employed for all Federal tax purposes, including income and employment taxes, if:

1. Substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other output, rather than to the number of hours worked, and

2. Their services are performed under a written contract providing that they will not be treated as employees for Federal tax purposes.

3. Companion sitters who are not employees of a companion sitting placement service are generally treated as self-employed for all federal tax purposes.

• Public Officials, Elected Officials and Public Officers have their own sets of rules if they should be classified as independent contractors, employees or other. Internal Revenue Code section 3401(c) indicates that an “officer, employee, or elected official” of government is an employee for income tax withholding purposes. However, in some special cases the law or a Section 218 Agreement may specify otherwise.

As shown above, it is not as simple at times to determine how a worker should be classified when determining payroll tax rules and regulations to follow as an employer.

It is best to be cautious and ask for professional assistance prior to starting a business with the incorrect method for reporting worker payments. Prevent the government from coming back and determining that your company has failed to properly report workers and wind up owing payroll tax debts that can be financially detrimental to your business.

Call for additional information or assistance e-mail: atggroup1@yahoo.com or call Martha De la chaussee at 323-344-2294.

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