On June 22, the IRS conducted a webinar called “The Examination Process for Employment Tax Returns.” The webinar was conducted by a panel of four experts, including Anita Bartels, IRS Program Manager in Employment Tax Compliance Policy, and Laird Macmillan, IRS Senior Policy Analyst in Employment Tax Compliance Policy.
What triggers an audit? Bartels discussed some of the circumstances that might trigger an audit. For example, if an employer files many 1099 forms but only one Form W-2, that might trigger an audit. The IRS may also look closely at an S corporation income tax return that reports very little compensation but has a lot of distributions. A Form W-2 and Form 1099 issued to the same person might also pique the IRS's interest, but it's possible for a person to receive both of these forms if he or she performs more than one service for the company. Bartels mentioned that some small businesses make the mistake of reporting a bonus to an employee on Form 1099 that should have been reported on Form W-2. Industry trends might also trigger an audit.
Accountable plan. Worker classification (employee vs. independent contractor) is generally a hot employment tax return examination topic, along with whether an employer has a legitimate accountable plan. Reimbursements (e.g., a mileage or tool allowance) are tax-free to the employee and aren't subject to withholding or payroll taxes if made under an accountable plan. To be treated as made under an accountable plan, a reimbursement must meet all of the following requirements: (1) the reimbursed expense must be allowable as an income tax deduction and must be paid or incurred in connection with performing services as an employee of the employer (business connection), (2) each reimbursed expense must be adequately accounted for to the employer within a reasonable period of time (substantiation), and (3) any amounts in excess of expenses must be returned within a reasonable period of time (return of excess requirement) [Reg. §1.62-2].
Michael M. Lloyd, who works for the law firm of Miller & Chevalier, said that the accountable plan issue comes up in almost every employment tax audit that his firm participates in. If the IRS determines that an employer did not have a valid accountable plan, all of the reimbursements will be reclassified as taxable compensation that is subject to withholding taxes.
State ramifications. The results of an IRS examination are shared with many state workforce agencies as part of the Questionable Employment Tax Practice (QETP) initiative. More than 35 states have entered into individual information-sharing agreements with the IRS.
Further information. There are many resources available to help employers obtain a better understanding of the IRS examination process. IRS Publication 3498, The Examination Process, includes the following topics: (1) “Your Return Is Going To Be Examined,” (2) “What to Do When You Receive a Bill from the IRS,” (3) “What To Do if You Agree or Disagree with the Examination Results,” (4) “How Do You Appeal a Decision?,” and (5) “After the Examination.” Page 11 of IRS Publication 594, The IRS Collection Process, has information on the collection of employment taxes. There is a video on the IRS Video Portal called “Your Guide to an IRS Audit.”
The June 22 webinar will be archived on the IRS website.