One of many lessons learned by governments the past three years is that unpaid taxes make economic downturns considerably worse.
With that lesson fresh in mind, the IRS earlier this year launched a major audit initiative intended to capture delinquent taxes.The audit, called the National Research Project (NRP), is particularly significant for contractors because it closely examines worker classification. Because practically all construction companies employ a combination of full-time workers and independent contractors, the audit may strike close to home to some in the construction trades.
NRP, which began in February this year with little fanfare and no advance warning, is randomly selecting 2,000 companies for employment tax examinations. The same number of companies will be selected each of the next two years. The program is designed to gauge compliance with employment tax law and related reporting requirements and gather information that will help the IRS select and audit future returns with the greatest compliance risk.
It should be pointed out that the NRP is not the same as the National Research Program, a separate and rather harmless IRS initiative designed only to streamline data gathering. NRP, on the other hand, is an aggressive program enacted to quickly and forcefully close the $290 billion gap between taxes owed and taxes collected. In the minds of many at the IRS and in Congress, NRP is expected to force delinquent taxpayers to finally "pay the piper."
For contractors, the odds of being selected for an NRP audit aren't high. But they should remind themselves that the same issues are likely to be raised in ordinary audits, too.
NRP audits are unlike any audits the IRS has undertaken since the 1980s. They are occurring in every geographic region of the country and are targeting both large and small taxpayers. Whether public or private, for-profit or non-profit, public sector or private sector, all are potential targets. In fact, the IRS has said 330 governmental entities will be audited as well.
Along with worker classification, the audits are closely examining officer compensation and reimbursed expenses. As for officer compensation, the IRS is focusing on two issues involving owner-employees: C corporations that pay unreasonably high salaries disguised as dividends, and S corporation shareholders who receive unreasonably low compensation to reduce unemployment taxes.
When it comes to reimbursed expenses, the IRS is looking for employee expense reimbursements that aren't paid through an "accountable" plan and, therefore, should be included in income and subject to employment taxes. Payments under a non-accountable plan, while they may be deductible by the employer, usually are taxable income to the employee. Essentially a reimbursement plan is accountable if reimbursed expenses have a business connection; employees have to substantiate expenses in writing within a reasonable time; and employees must return any excess reimbursements or advances within a reasonable time.
The issue of worker classification, however, poses the biggest threat to contractors. The IRS states in its literature that "the use of subcontractors is common within the construction industry. Many taxpayers treat employees as subcontractors to avoid paying employment taxes. The agent may need to seek guidance from an employment tax specialist when confronted with potential employment tax issues."
The issue of whether someone is an "employee" or subcontractor has always been a thorny tax issue. The general rule, according to the IRS, is that "an individual is an independent contractor if the person for whom the services are performed has the right to control or direct only the result of the work and not the means and methods of accomplishing the result.''
Here is an example: Joe Jones, a plumber, submits a job estimate for his work on a new office tower at $16 per hour for 400 hours. He is to receive $1,280 every two weeks for the next 10 weeks. This is not considered payment by the hour. Even if he works more or less than 400 hours to finish the
