IRS Payroll Tax Audits
By Thomas Howell - Senior Manager, Tax & Business Services
One area that the IRS is currently focusing on is payroll taxes.They are seeking to recoup what they consider lost revenue attributable to payroll taxes that are unreported and unpaid.Employers should take the necessary steps to make sure they are complying with the various payroll tax rules and reporting requirements.
Two specific areas where the IRS is targeting its efforts are:
- Payroll Tax Wage Bases, and
- Independent Contractor Status.
Employers must generally withhold payroll taxes from their employees’ wages. FICA (Social Security) tax must be withheld at the rate of 6.2% on an employee’s wages up to the “FICA Wage Base” of $117,000 for 2014, which increased to $118,500 for 2015. Medicare tax must also be withheld on all wages paid to an employee during the year. FUTA tax is paid by the employer on the first $7,000 paid to an employee during the calendar year.
When an employee moves among separate related employers, the issue arises whether the FICA and FUTA Wage Bases need to be “restarted”. Generally, movement among related employers causes a restart of the FICA and FUTA Wage Bases, but there are exceptions. The three most common exceptions to the restart rule occur when there are certain concurrent employees, transferred employees in companies during an acquisition, and when there are leased employees.
The first exception that allows a single FICA and FUTA Wage Base to be used falls under the “common paymaster” provisions of the IRS Code. When two or more “related” companies employ the same person concurrently, and only one of the companies pays that person, the paying company is referred to as the “common paymaster”. Corporations are considered “related” if they are members of a controlled group of corporations related through 50% or more common ownership.
The second exception may apply when there are transferred employees in an acquisition. When one company acquires the stock of a second company and the second company then becomes a subsidiary of the acquiring company, the existing FICA and FUTA Wages Bases should continue to remain intact. In the case of an asset acquisition transaction, the FICA and FUTA Wage Bases may continue if certain “successor” employer rules are met. The successor employer rules are met if the successor employer acquires substantially all the property used in the trade or business of the predecessor employer, and if the employee was employed by the predecessor employer immediately prior to the acquisition and then continues to be employed by the successor immediately after the acquisition.
The third exception is when there are leased employees. In this situation, one FICA and FUTA Wage Base generally applies because there is only one legal entity that is actually the employer of the leased employees who move among the various legal entities to provide services.
Generally, workers are classified as either common laws employees or independent contractors for employment tax purposes. There are many established factors that help determine whether a worker is an employee or an independent contractor. The overriding factor is that if both the manner and method of the work performed is determined by the recipient of the worker’s services, then the worker is properly classified as an employee.
If an employee is misclassified by an employer as an independent contractor, then the IRS may assess penalties for non-compliance. The severity of the penalties depends on whether the misclassification was determined to be willful or not. During recent years, the IRS has been very successful in getting companies to switch their workers’ classification from independent contractor to employee. Though the IRS is bearing down on employers who misclassify employees as independent contractors, they have provided several forgiveness programs in order to help employers correct these misclassifications.
An employer that fails to properly withhold and make payment of its payroll taxes becomes liable for the full amount of taxes not withheld, plus interest and penalties, so it is imperative for employers to review their current payroll tax processes to be sure they are in compliance.