Employment: IRS Payroll Audits to Target Misclassification of Workers


Our friends at the Internal Revenue Service have a new pet project. They are conducting a "comprehensive" employment tax compliance study. The payroll audit will focus on employment tax underreporting, which accounts for the big portion of the difference between what taxpayers owe and what they actually pay. The audits will include detailed examinations of Forms 941 and 1099 for each of three years beginning with 2007. The IRS will select 2000 organizations to participate, including large and small private sector entities and non-profit organizations.

The payroll audit will include areas such as fringe benefits, executive compensation, and accountable plans. The audit will also pay particular attention to worker classification. If a worker is classified as an independent contractor rather than an employee, the employer has no obligation to withhold income tax or Social Security and Medicare payments, or make employer contributions. And even though an employer might issue a Form 1099, the worker may neglect to make the required payments. Because independent contractors are less expensive workers than employees, misclassification may appear to have a temporary upside, particularly during economic downturns. Misclassification of a worker as an independent contractor, however, can result in liability for the employment taxes not paid. And, in some cases, the IRS will assess a penalty equal to 100% of the taxes not paid.

The IRS has developed, and recently refined its criteria for determining whether a worker is an independent contractor or an employee. Generally, the IRS considers whether the employer has a right to direct and control how the worker performs the work, whether the employer has the right to control the financial aspects of the worker's job, and the extent of the relationship between the employer and the worker. If the payroll audit gives any indication of a worker misclassification, the IRS will use these criteria to determine the relationship.

Even if you are not selected for participation in the payroll audit, we suggest that you review your worker classifications. If you have questions or need help, call us.

By Rebecca M. Fowler, rfowler@dsda.com

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Justin B. Munn

Justin B. Munn

Justin represents clients throughout Oklahoma in family law, civil litigation, guardianships, adoptions, estate planning, trust and probate matters. 

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