Beginning this month, the Internal Revenue Service (IRS) will initiate its Employment Tax National Research Project (NRP), which it previously announced in November 2009. The IRS has indicated that over the next three years, 2,000 employers will be randomly selected each year for examinations that the IRS has said will be “comprehensive in scope.” Employers of all sizes and types are expected to be targeted by the examinations, including tax-exempt entities. These audits can result in potential assessments, in addition to providing the IRS with information to develop base lines for taxpayers’ voluntary compliance, future audit selection and issue refinement.
The examinations will focus on compliance by employers with employment tax law and related reporting requirements. Employment taxes and related issues generally include the Social Security tax, Medicare tax, federal unemployment insurance tax and personal income tax withholding. The IRS has indicated that company records relating to employment tax returns and related issues will be subject to review during the examinations. Employment tax returns (and related documents) will likely be subject to a detailed lineby- line review by the IRS during the examinations.
Although the examinations will not be limited in scope, the IRS is generally expected to focus on employment tax returns for the 2007 and 2008 tax years, and give particular emphasis to the following five employment tax areas:
- Classification of Workers (employee versus independent contractor)
- Fringe Benefit Arrangements (e.g., private use of aircraft, educational assistance, employee discounts, employer provided meals and lodging, and other working condition fringe benefits)
- Executive Compensation Arrangements (e.g., Code Section 162(m) compliance, Code Section 409A compliance, reasonableness of compensation)
- Back-up Withholding, and
- Form 1099 Requirements
According to the IRS, the goals of the NRP are to (1) collect statistics to enable the IRS to compute the tax gap attributable to a failure of businesses to pay employment taxes and (2) provide information that will help the IRS identify and focus on tax returns with the greatest risk for non-compliance.
What Employers Should Be Doing Now to Prepare Themselves for a Potential Examination
The IRS has indicated that the examinations will be comprehensive. Therefore, in preparation for a possible examination, employers should plan ahead and consider initiating reviews of their own to gauge internal employment tax compliance. The results obtained from any internal review will enable the employer to identify potential issues and weaknesses that may exist in its employment tax practices and control procedures, allow the employer to modify any existing non-compliant tax policies or procedures going forward and take corrective action.
An internal review could also provide an estimate of any financial liability to which the employer may be exposed as a result of any compliance failings. Any internal review should be done in consultation with experienced audit and employment tax experts. If your company is selected for an NRP audit, plan to establish a chain of command and retain outside expert advisors as early in the process as needed to respond to review employment tax returns, respond to Information Document Requests and advise regarding audit strategy. The IRS is implementing new information- and document-gathering techniques, with an emphasis on accessing electronic data, questioning responsible senior management, and cross-checking information with various third parties — companies should anticipate these types of inquiries early in the audit process to minimize potential adjustments and the burdens of compliance.