Over the last few weeks, the Internal Revenue Service has announced further details about its plan to conduct a threeyear nationwide employment tax audit initiative beginning this month. The audit initiative will focus on 6,000 businesses across the country and across industries, 2,000 businesses each year. Though the majority of the businesses will be small companies, the IRS will audit larger companies as well. The initiative grows out of a continuing research effort within the IRS called the National Research Program (NRP) and is designed to address a perceived tax shortfall in the collection of employment taxes due primarily to misclassification of employees as independent contractors. Some of us will recall a similar audit effort about 25 years ago; many of these audits focused on the classification issue.

The current initiative will focus on additional areas such as fringe benefits, including section 409A deferred compensation (which is already receiving coordinated audit attention), executive compensation, backup withholding, and Forms 1099. These audits promise to be thorough and time-consuming and may run concurrently with an income tax audit or precipitate an income tax audit if the auditor should learn information suggesting that income tax items need a closer look. The first group of selected businesses should expect to receive audit appointment letters in February and March.

We understand that some states are preparing to conduct similar employment tax audits with a similar revenue-raising goal. They may find some assistance in that effort through tax information sharing agreements with the IRS whereby audit information is transmitted between the federal and state agencies. States may also keep apprised of misclassification actions being filed against employers around the country. Our firm recently successfully defended against such an action brought against a logistics company in California state court.