How do I prepare for an employment tax audit?

If your business hires independent contractors, you need to make sure that they meet the criteria of ‘independent contractors’ for payroll tax purposes. The IRS can conduct an employment tax audit, and they may determine that the workers are employees instead of independent contractors.

Losing an employment tax audit can be crippling for a business. The taxes owed, penalties, and interest can financially ruin many companies.

You need to be clear on the rules and regulations, and how to address them should your business finds themselves in an employment tax audit.

What is an employment tax audit?

The Internal Revenue Service has an active program of examining how businesses treat employees for tax purposes. Since businesses do not have to withhold taxes nor pay social security tax when hiring independent contractors, they have an incentive to treat workers as independent contractors rather than employees. The Internal Revenue Service will use Section 530 of the Revenue Act of 1978 to determine if the business is following the tax regulations for their employment/payroll taxes.

Section 530 is not part of the Internal Revenue Code, so many tax dispute companies aren’t familiar with this section. We understand this section and can help determine if you qualify.

Additionally, if the business cannot convince the Internal Revenue Service that its workers are independent contractors and not employees using Section 530 arguments, the Internal Revenue Service also will consider up to 20 factors which can help determine if a worker is either an employee or an independent contractor. Among factors indicating that a worker is liable for paying independent contractor taxes are if he or she is available for work with other businesses, has an investment in his own tools and facilities, pays his own expenses, is paid by the project rather than by the hour, and sets his own hours of work. Factors which indicate a worker is an employee, and therefore the employer must withhold taxes and pay social security taxes, include if the worker is trained by the business, takes instructions from the business, works for the business on a regular basis, does the work at the employer’s premises, and has to be at work during certain hours.

Understanding the IRS Section 530 Relief Requirements

If your business has been selected for an employment tax examination, you may be entitled to Section 530 relief. If you meet the requirements of the exemption below, you will not need to pay employment taxes on your workers. There are certain criteria you must meet to qualify for the IRS Section 530 Relief. If you don’t meet these criteria, it’s likely that the IRS will determine whether your workers are independent contractors or employees, with respect to paying employment taxes. Section 530 Relief Requirements.

To receive relief, you must meet all three of the following requirements:

Reporting Consistency – First, you must have timely filed all required federal tax returns (including information returns) consistent with your treatment of each worker as not being an employee. This means that if you gave a worker independent contractor status and paid them $600 or more, for example-you must have filed form 1099-MISC. Relief is not available for any year and for any workers for whom you did not file the required information returns.
Substantive Consistency – In addition, you must have treated the workers, and any similar workers, as independent contractors. If you treated similar workers as employees, this relief provision is not available.
Reasonable Basis – Finally, you must have had a reasonable basis for not treating the workers as employees, such as a legal ruling, a past decision of the IRS, or advice received from a lawyer or accountant that had knowledge of your business operation.

Employment tax audits are serious and can have consequences that span several tax years. For these reasons, they are best handled by an experienced tax attorney. Contact us today if the IRS has contacted you about an employment tax audit.

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