Hot Button IRS Issues

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Woeful Tales of Tax

Withholding:

Helping

Your Client Avoid IRS

Employment Tax Issues

Presented By:

Anthony P. Daddino, J.D.

901 Main Street, Suite 3700 Dallas, TX 75202 214.744.3700 800.451.0093

fax 214.747.3732 [email protected]

www.meadowscollier.com

Hot Button IRS Issues

• Worker Misclassification

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Meadows, Collier, Reed, Cousins, Crouch & Ungerman, LLP 3

Worker Classification:

Current Conditions

Worker Classification:

Current Conditions

• In the past two years, federal and state agencies alike have mounted a full assault on businesses that utilize the services of independent contractors

• Among the industries targeted: sales (all types), construction (including subcontractors),

trucking/freight, and transportation (i.e., taxi companies)

Worker Classification:

Current Conditions

Worker Classification:

Current Conditions

• Specific Examples

– Congressional Efforts:

§ Six bills introduced in the past 2 years

§ One such act would make it unlawful for any person to fail to accurately classify a worker, and provide for huge liquidated damages for maximum hours, minimum wage, and notice classification violations

§ Such act would also amend FLSA to require every person to keep records of independent contractors and provide notice to each new worker, including their

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Worker Classification:

Current Conditions

Worker Classification:

Current Conditions

• Specific Examples (continued)

– White House FY2012 Proposals

§ $46 million budget increase to IRS (and some to the states) to combat worker misclassification

§ Empower the IRS to require prospective reclassification § Limit Section 530 relief

§ Proposed revenue impact: $8.71 billion

– IRS Efforts:

§ National Research Project (more on this later)

Worker Classification:

Current Conditions

Worker Classification:

Current Conditions

• Specific Examples (continued)

– Collaborative efforts:

§ Increased information sharing agreements among the IRS, DOL, and individual states including Texas

– Sharing of investigation results and cross referrals

– Effect: Challenges to even low dollar disputes can be important § DOL, IRS, and state authorities working to promulgate

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Worker Classification:

Why the Hubbub?

Worker Classification:

Why the Hubbub?

•

• Survey SaysSurvey Says: Revenue

– Generating revenue through enforcement rather than raising taxes

– Current estimates reveal that misclassification results in $54 billion of underreporting of employment taxes

• The New Yorkexample

– Task force on worker misclassification

– Over a 3 year period, the Task Force conducted 67 sweeps which identified nearly 35,000 cases of misclassification and $457 million in unreported taxes and more than $13.2 million in unemployment insurance taxes

– In comparing 1099s to W-2s, the Task Force identified an increase in independent contractors of 20%, compared to a 0.5% increase in employees

– Regarding restaurants, 95% of companies had some type of misclassification

Worker Classification:

Why the Hubbub?

Worker Classification:

Why the Hubbub?

• Other examples

– Targeted audits in Ohio resulted in reclassification of

47% of workers

– Similar effort in Colorado revealed 33.9% of employers

misclassified workers

– At least 20 states have undertaken an effort to combat

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Worker Classification:

Why the Hubbub?

Worker Classification:

Why the Hubbub?

• The Power of Statistics

– Misclassification:

§ IRS: 15% of businesses have misclassified workers – approximately 3.4 million workers

§ DOL: 30% of businesses

– Compliance:

§ 99+% of workers who receive a Form W-2 report income

§ Only 77% of workers who receive Form 1099 report income

§ Less than 30% report income when Form 1099 is not issued

Worker Reclassification:

Be Afraid… Be Very Afraid

Worker Reclassification:

Be Afraid… Be Very Afraid

• The “Sting” of Worker Reclassification

– Financial liability

– Tort liability

– Employee Benefit Issues

§ Plan Qualification and Benefits

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IRS Attacks on Worker Misclassification

• Reorganization of IRS specialists

• Information sharing with DOL and states (TX) Increase in audit coverage

– Increase in number of examinations

– New systems that compare 1099 and W-2 filings to

that of industry competitors

– New systems that flag businesses that issue Forms

1099 of $25K or more to at least 5 workers that have no other income source

• New NRP Study

IRS “WMD” – National Study

• National Research Project

– 2,000 returns for 3+ years

– Began in 2010

– Central Focus: worker classification

– Other Areas: fringe benefits, officer compensation,

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IRS National Study

• Details of NRP

– Mostly small/midsize business; some large business

and tax-exempt

– Specially trained workforce

– Verification of “every line”

– Surrounding returns, including officer returns, will be

examined and possibly referred

IRS National Study

• NRP Stated Goals

– Reduce Tax Gap

– Improve Audit Selection/Techniques

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Rules for Worker Classification

• Groupings of Workers

– Common Law employees

– Statutory employees

§ Perishable food truck drivers, domestic workers, full-time insurance agents and travelling

salespersons. Also, generally officers

– Non-statutory employees

§ Direct Sellers, real estate agents, and companion sitters

Rules for Worker Classification

• Determining a Common Law Employee

– Looking to degree of control over how the work is

performed

– Facts and circumstances test

– Generally accepted 20-factor test

– These factors are categorized as: Details of Work

Performance, Expenses, Compensation, Duration of Work Position, and Structure of Work Position

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Rules for Worker Classification

• Details of Work Performance

– Instructions

– Training

– Set Hours of Work

– Full-time Required

Rules for Worker Classification

• Details of Work Performance (continued)

– Order or Sequence (i.e., Work Pattern)

– Oral/Written Reports

– Skill

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• Expenses of Work Performance

– Payment of Business/Travel**

– Furnishing Tools and Material Names

– Significant Investment

– Licenses/Taxes

**IRS Favorite

Rules for Worker Classification

• Compensation for Work Performance

– Payment in fixed intervals**

– Realization of Profit/Loss

– Insurance

– Benefits

**IRS Favorite

Rules for Worker Classification

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• Duration of Work Position

– Right of Discharge

– Right to Terminate

– Continuing Relationship

Rules for Worker Classification

• Structure of Work Position

– Integration

– Whether Worker Has the Right to Delegate

– Hiring, Firing, and Paying Assistants

– Working for More than One Firm at a Time

– Making Services Available to the General Public

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Rules for Worker Classification

• Structure of Work Position(continued)

– Government Rules and Regulations

– Industry Custom*

– State Law Characterization**

* IRS does not recognize.

** TRAP FOR THE UNWARY: IRS disregards this factor, as does Tax Court, but IRS will use to its advantage and has easy access now to info.

Rules for Worker Classification

• Structure of Work Position(continued)

– Incorporation

• Location of Work Performance

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Worker Classification:

Practice Tips

Worker Classification:

Practice Tips

Tips for Identifying and Addressing Potential Worker Classification Issues

Practice Tips

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Practice Tips

• Review current agreements

– Both employment and independent contractor

agreements

– Match up contracts to IRS tax filings

§ Be wary: mixed Form 1099 and Form W-2 filings

– Compare contract terms to actual behavior

– Prepare agreements when necessary

– Identify risk factors

Practice Tips

• Improve current contracts

– Suggest worker provide services through an entity

– Include travel and other expenses in overall fee

– Arrange for worker to hire assistants

– Require invoicing for payment and attempt to base fee on non-hourly basis

– Fee arrangements should contemplate potential loss

– Have worker provide own supplies – possibly consider subleasing office space and administrative services

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Practice Tips

• Develop Mitigation Strategies

– Identify and quantify reclassification risks

– Available Relief

§ Section 530 Relief

§ Employee Payments

§ Other Code-based Relief

Practice Tips

• Mitigation Strategy: § 530 Relief

– Prevents retroactive reclassification

– Nullifies all tax liabilities, penalties and interest

– Applies strictly to employers – not individual workers

– Prevents IRS from issuing regulations/rulings on

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Practice Tips

• Section 530 Requirements: There are three (3)

major requirements

– Tax Return Test

– Position Test

– Reasonable Basis Test

Practice Tips

• Section 530 Relief: Tax Return Test

– All federal tax returns must be filed. No 1099 is fatal

– Returns filed must reflect consistent treatment of

worker as an independent contractor – no W-2s

– Each tax period stands on its own

– Are timely-filed returns required? Maybe

– What about inconsistent state filings?

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Practice Tips

• Section 530 Relief: Position Test

– Taxpayer and predecessors have not treated workers

(and substantially similar) as employees

– Taxpayer will not lose the right to claim §530 relief for

periods before the periods in which he treats the workers or substantially similar workers as employees

– Legal vs. Illegal – no basis for differentiation

– Sporadic Form 1099 filings – not a consistency issue

Practice Tips

• Section 530 Relief: Reasonable Basis Test

– Reliance on legal authority at the time of classification

– Reliance on past IRS audit

§ Pre-1997 audits – need not involve classification § Expansively applied by Fifth Circuit

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Practice Tips

• Section 530 Relief: Industry Custom

– Employer is entitled to rely on a long-standing recognized practice of a significant segment of the industry

§ Long-standing practice – not more than 10 years

§ Significant segment – not more than 25% of the industry

– Industry custom is difficult to establish

§ Proof requires more than direct testimony, so cooperative competitors (or undercover action) is required

§ Need for contemporaneous documentation

§ Difficulty in defining geographic area and occupation

Practice Tips

• Other Mitigation Strategies: Employee Credits

– Employer receives credit for substantiated tax

payments by employees. Employer remains liable for any penalties

– Required Forms: Form 4669 (employer) and Form

4670 (employee)

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Practice Tips

• Other Mitigation Strategies: IRC § 3509

– Limits the liability to 1.5% of the wages paid and 20%

of the employee's share of FICA taxes

– Increasing to 3% and 40% when no Form 1099s filed

– Does not apply if: (1) intentional disregard of

obligation; or (2) withheld but failed to pay

– Still liable for employer FICA and FUTA taxes

– Employer may not collect from the employee and is

not entitled to any offset liability under §3402(d)

Practice Tips

• Take Proactive Measures

– Train HR personnel on proper classification

– Document initial determinations and reasons

therefore

§ This includes classification based on competitors’ classification for purposes of Section 530 defense

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Other Classification Issues

• Limitations Periods

– There is no limitations period where a employment

tax return not filed

– Normal mitigation provisions do not apply to

employment taxes (i.e., context of related taxpayers)

– Some potential mitigation relief available under IRC

Sec. 6521

Other Classification Issues

• Form SS-8 Determinations

– Request for IRS to determine employment status

– Applies only to past treatment of workers, not future

– May be filed by employer or employee

– Non-binding determination

§ Not subject to Appeals review

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Other Classification Issues

• Form SS-8 Determinations

– Popular IRS passive/aggressive tactic

§ “You are responsible for satisfying the employment tax reporting, filing and payment obligations that result from this determination. Your immediate handling of this correction and your prompt payment of the tax may reduce penalties and interest”

– If follow – lose Section 530 relief

– Trap for unwary: SS-8 office can, and often does,

make an audit referral

Proper Classification is not enough

IRS is cracking down on proper documenting of independent contractors, cross checking Form 1099 information

When taxpayer identification numbers do not match up, the IRS will send the business a benign notice that may

Moving Beyond Classification to Proper

Documentation of Workers

Moving Beyond Classification to Proper

Documentation of Workers

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Worker Documentation, Normally

1. Payee provides a tax ID number on a Form W-9

2. Business files a Form 1099-MISC reporting the amount of payment, name, address, TIN of the worker and the year

3. If the TIN is incorrect or cannot be verified, § 3406 requires the business to backup withholding at a rate of 28%

4. This withholding applies to payment once the business is notified by the IRS that the TIN is not correct

5. Notification is by the use of a CP2100 or CP2100A

6. Notices are typically sent September of the year the Forms 1099 are filed

IRS Notice: CP2100

Backup withholding must occur after:

• Business has confirmed that there is a name and TIN mismatch

• The business sends the worker within 15 days a letter requesting a Form W-9

• The worker fails to provide a signed W-9 within 30 days of the IRS mismatch notice

• Withholding will continue until a W-9 is received

• The business must retain a record of mismatched notices in case the new W-9 proves to be false and the IRS sends a

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Double Duty: Second IRS Mismatch

A second mismatch notice within 3 years creates new requirements for the business:

– Letter to worker within 15 days requesting

validation of TIN from either the Social Security Administration or the IRS within 30 days

– Backup withholding begins on the 31st _{day and}

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1. A business that fails to backup withholding may be liable for the tax and may be subject to penalties under §§ 6651, 6656 and 6672

2. Under § 6672 a “responsible person” may be held liable for the tax that was not withheld

3. $50 per return penalty (maximum of $250k) on any person who fails to file complete Form 1099

4. Penalty increases to greater of $100 per tax return or 10% of the aggregate amount of the items to be reported, for intentional disregard of the information reporting requirements. There is no maximum limit. “Intentional disregard” exists when there is a knowing or willful failure to file or failure to include correct information, including a correct taxpayer identification number

Backup Withholding Woes

- Classification based on documentation: United States vs. Evensen

- Changing from IRS agents with sharpened

pencils to those with guns and badges

Backup Withholding Woes

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To ensure compliance with U.S. Treasury Regulations governing tax practice, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any penalties under U.S. Federal tax law, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Anthony P. Daddino

Partner

Anthony P. Daddino

Partner

Mr. Daddino is a partner with the firm who specializes in resolving federal tax controversies. He has extensive experience representing taxpayers in a wide variety of tax disputes, ranging from income tax and employment tax matters, to estate and gift tax, and employee benefit and exempt organization matters. Mr. Daddino routinely represents taxpayers administratively before IRS Examination and IRS Appeals, as well as in litigation before the Tax Court and federal district court. As a trial attorney, his recent experiences include trying to verdict partnership tax cases before the Court of Federal Claims and the federal district court for the Western District of Texas.

Mr. Daddino is a law professor at Southern Methodist University Dedman School of Law, where he teaches Corporate Income Taxation. He is also a frequent speaker on tax controversy and ethics issues and an author in the

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