Much has been said in previous articles written by Linda H. Blasdel about the importance of worker classifications relative to utilizing the talents of temporary staff.  This issue affects businesses of any size, and more needs to be said — just short of a warning – that this risky issue is about to rear its ugly head. 

In the news today, an article was posted by AOL explaing in detail reasons companies should “should be worried about random audits of employee tax records.”  The following is a direct quote of that article, written by Barbara Weltman of AOL Small Business and posted February 17, 2010.  More than likely, this article can be retrieved and viewed from the AOL News archives.

“Uncle Sam is going door-to-door and he wants to see your tax returns.  Well, sort of.  For the next three years, the IRS plans to randomly audit thousands of businesses.  How you can prepare for the worst.”

“If you employ anyone in your business — even yourself – you may receive a notice in the mail sometime within the the next three years telling you that you’ve been selected for a special employment tax audit.  The government is conducting a research program in which it will select 6,000 companies at random for comprehensive audits related to employment taxes.  The government is collecting data that will be used in the future to better target and review employment tax returns.”

“Who Can Be Audited?”

“Starting now, the project will select 2,000 companies at random each year for three years.  This audit program runs the gamut from large multinational companies employing thousands of people to one-person firms.  No industries have been excluded from this audit program.  All types of business entities  — from sole proprietorships with employees to corporations — can be targeted.  Even if you have done everything right, you may still get a call.” 

“What Will Be Audited?”

“Most likely, the auditors in this project will be reviewing employment tax returns for 2007 and 2008.  Although the IRS is not restricted to these two years — and can go back ever farther where appropriate returns have not been filed or for other reasons.”

“The IRS auditors will go over line by line 941 forms, which are the quarterly employer tax returns.  They will also review related employment tax forms, including Form W-2 and Form 1099-MISC for payments to independent contractors, and the company’s federal tax return, such as Schedule C of Form 1040 for sole proprietors or Form 1120 for C Corporations.”

“What To Do Now?”

“Since selection for this audit is random, there’s nothing you can do to prevent it.  What you can do is be prepred and always follow good business practices so you won’t owe additional taxes if you are audited.  Gather the following  if you don’t already have them together:

*Copies of all employment tax returns you’ve filed in the past three years.  These include Forms 940 and 941 or 944.

*Copies of all W-2 Forms provided the employees in the past three years.

*Copies of Form 1099-MISC given to workers that you’ve treated as independent contractors who received more than $600 in payments from you within the year, along with any contractors’ agreements you’ve signed.”

“In Case Of An Audit”

“If you receive an audit notice, it is generally advisable to bring in a tax professional who can represent you.  Yes, this representation can be costly, but it may be cheaper than the penalties and interest you could face if the auditors find problems that a tax profession could have deflected.”

“Review your worker classification.  If you treat workers as independent contractors, it can save your company taxes but only if this classification is correct.  It can cost you in back taxes, interest and penalties if the IRS successfully reclassifies them as employees.”

“Keep employment tax records.  While income tax returns generally are saved for only three years, it’s essential to keep employment tax returns and related records for four years.  This includes time slips, expense account reports, and other employee-related paperwork.”

“Final Word”

“If you receive a notice in the mail that you’ve been selected for audit, don’t panic.  You can get through it, if you’re prepared by following the suggestions included here.  Above all, don’t ignore the notice — the audit threat won’t go away and not responding can make things worse.”

“Barbara Weltman is an attorney, author of several business books including J.K. Lasser’s Small Business Taxes, and trusted professional advocate for small business and entrepreneurs.  She is also the publisher of Idea of the Day and monthly e-newsletter Big Ideas for Small Business, both available at www.barbaraweltman.com and host of Build Your Business radio.  Follow her on:

 Twitter at twitter.com/Barara Weltman.”

As emphasized in the Interim article written by its President, Linda H. Blasdel and posted on www.houstonbusinessdaily.com along with the information shared above, should be more than sufficient evidence to support the advice of Interim, i.e., always seek the service of a third-party payroll facilitator when utilizing the services of temporary staff. 

More information on this subject may be seen on the website of The New York Times at www.NYTimes.com dated February 18, 2010 entitled:

U.S. CARACKS DOWN ON ‘CONTRCTORS’ AS A TAX DODGE.

For more detailed information on this subject and other employment issues, please visit the Interimwebsite at  www.interimtexas.com where you will also find useful contact information.

Interim Compensation Source, Inc., a third party employer of record payrolling entity in business in Houston since 2000, is experienced in addressing and assisting employers to guard against falling victim to the pitfalls of worker misclassification and resolve an issue before it becomes a problem.

Even among the most seasoned, informed employers, there is a vast misunderstanding of the difference between W-2 employees and 1099 independent contractors.  Knowing and understanding the difference is vital to employers, and not knowing and understanding the difference can result in large tax penalties and IRS “red flags.” 

In 1987, the IRS published an extensive, easily misunderstood 20-factor test to assist employers in determining the employment status and classifying workers — W-2 employees or 1099 independent contractors.  In 1996, the IRS rewrote to simplify the determination guidelines and included three main categories of behavioral control, financial control and type of relationship.  The IRS still maintains, “the determination is complex but is essentially made by examining the right to control how, when and where the person performs services.”

Behavioral Control:  Facts that demonstrate whether the employer directs and controls — or has the right to direct or control — how the worker performs the task, including training and instruction about when, where and how to provide the service.

Financial Control:  Defined by analysis of the facts that reflects the employer controls, the economic aspects of the worker’s job, including whether the worker (a) has expenses not reimbursed by the employer, (b) has an investment in tools or facilities, (c) works for more than one employer at the same time, (d) is paid by the job or by the hour or (e) can suffer a loss by taking the work.

Type of Relationship:  Facts showing the relationship betwen the parties, including (a) written contracts, (b) whether the worker receives benefits, (c) the duration of the work and (d) the extent to which the services are an aspect of the employer’s regular operations.

Under the microscope of an audit — every employer’s nightmare and greatest fear — if the IRS determines a worker is or was actually a W-2 employee, rather than a 1099 indepedent contractor, and the worker’s compensation is or was documented by the issuance of a 1099, rather than a W-2, be assured THE TAX MAN COMETH!

An employer’s obvious question is, “under what circumstances might my company be audited and worker compensation practices scrutinized?”  Answer is simple.  Let just one worker classified as a 1099 independent contractor file for unemployment, and the “jig is up!”  The employer may have been given and used in its defense all legitimate paperwork to show the 1099 independent contractor either has a DBA or is incorporated and received assurance from the 1099 independent contractor, “I will never for file unemployment.”  All documentation and assurances become moot points once the State Workforce Commission and IRS become players in the game.

Upon the occasion of just one 1099 independent contractor filing for unemployment benefits, the IRS will immediately “kick into action” the three-point criteria test explained earlier herein to make a determination, which may result in a costly, time-consuming audit lasting for as long as three to six months.  And, it is highly likely, if the employer fails to meet just one of the requirements of the criteria, he will be found in violation of the determination code and issued a big tax and penalty bill.  Depending on whether the violation was intentional or unintentional, the components of the employer’s tax liability will surely include unmatched social security and medicare benefits payments, unpaid State and Federal unemployment taxes and can ultimately hold the employer responsible for the worker’s unpaid of short-paid income taxes.  There is also the definite possibility of additional fines and penalties being levied on the employer for failure to timely file required returns and pay taxes.

If has been reported by many reputable sources that “workers classified as 1099 independent contractors, rather than W-2 employees, has cost the federal government more than $4.7 billion in income taxes alone recently.”  This fact is sufficient to assume the federal government, given the current challenging economy, is “ripe” at any time to “kick into action” worker misclassification audits.

Contact Interim for more discussion on this subject at www.interimtexas.com

It is a recognized fact that successful companies focus on business development, reduction of G&A expense and limitation of liability exposure to increase the bottom line.  To that end, entities often review hiring practices and elect to employ temporary staff on an as-needed basis because in so doing, the company is not required to offer either health insurance benefits or holiday and vacation pay, significantly reducing employer payroll burden and benefit expense.  While the G&A savings are significant with temporary staff, the liability of having temporary staff on the company payroll can be risky business.  That is where the services of a payroll outsourcing company can be of benefit. 

A payroll outsourcing company asumes the position of employer of record and, as such, provides the employer, general liability and workers’ compensation insurance coverage, matches social security and medicare withholding, is responsible for both State and Federal unemployment claims and issues year-end W-2 statements.

While outsourcing temporary staff payrolling has financial advantages over the short-term, there are even more advantages to consider over the long term.  Specifically, as an example, a company’s workers’ compensation rate and multiplier are a function of workers’ injury claims.  One major claim can translate to a sizeable rate and multiplier increase, thus affecting the company’s rate structure for as long as three years.  Because employers must cover all staff on its payroll with workers’ compensation insurance, there is no choice other than to pay the increased rate.  The same is true of the Texas Workforce Commission, the governing body for State unemployment claims.  An employer’s experience factor is a function of the number of claims it has; and, with a number of claims against the company’s account, the rate can and will increase annually, based on the chargeback amount. 

Then, worthy of even more concern, there is the issue of liability for lawsuits of any kind filed for any reason.  The payroll outsourcing company, functioning as the employer of record, virtually eliminates any corporate liability for legal action brought against it by temporary staff.  The payroll outsourcing company covers the temporary staff with liability insurance and names the client company as co-insured.

The corporate pitfalls cited herein are only a few examples of why choosing a reputable payroll outsourcing company to serve as a third-party facilitator when utilizing temporary staff is the most prudent option.

For more information on this an other matters of employment, please visit Interim’s website at www.interimtexas.com