As the Internal Revenue Service continues to endure more and more budget cuts, they continue to look to find new areas for additional tax revenue. Although overall individual and business audit rates remain very, very low (average individual rates of audit are .84% and average business rates of audit are .60%), the Department has increased focus in several areas which have brought in large revenue dollars. Payroll and compensation has been one such area.
The Department has made many departmental changes in its focus of this area. In the past the Department has been lenient on wiaving penalties and enforcement. Recently they have made a clear change in no longer easily waiving penalties and have further pursued civil injunctions against both companies AND the officers/owners who repeatedly pay late or fail to file.
Many companies fail to properly classify workers as employees and often treat many as independent contractors thereby eliminating the payroll tax burden on the company. The Department is working with states to help find these misclassified workers and intensely seeking back payroll taxes and large penalties. The Department is; however, giving businesses the opportunity (that is before they get found out) to correct this misclassification and pay a modest fine in exchange for the Department not auditing prior periods. There is a long list of standards for who can be claimed as an independent contractor and who is an employee, and even more court cases on both sides. Merely having someone sign a form that says they are an independent contractor is not enough, you must be able to support the stance with legal backing. It is clear that the Department will continue to put businesses to the test on this point.
A new and large area of focus for the Department has been over and under compensation of company owners/officers. As one can imagine, if changing your own compensation can help lower your overall taxes, it is human nature to want to do so. In a regular ‘C” corporation both the company pays income taxes and the owner. Therefore, many times, larger compensation to the owner helps to reduce overall taxes (by eliminating having to take dividends and thereby pay that second layer of tax). In a subchapter ‘S’ corporation, it is just the opposite. Since the corporation itself pays no tax, the more compensation the owner/officer takes the more Social Security and Medicare taxes they have to pay. The temptation here is to make compensation lower than normal. Compensation needs to be reasonable (no matter how low or how high) and something you can justify based on your own company’s situation so proper planning and documentation is needed.
The Department has spent nearly six years studying payroll information from various resources and on business returns in order to help them determine incorrect reporting on fringe benefits, tips, tax payments and actual compensation. Expect them to use this information to raise their tax revenues and as they find more money in this area, expect them to continue to refine the analyzation methods they use in order to find more and more companies and individuals not in compliance with their strict and colossal tax code.
Is your company handling all this properly? We hope so since the risks are not worth the rewards. But hoping wont get things done properly. Planning and reviewing your current situations is the only way to stay ahead of the Department. That’s where we come in. Reilly, Penner & Benton LLP can help you review your tax positions and situations to help you through the maze of this area. We are here to help so don’t hesitate to contact us.