Audit I Forget..?

While many tax payers are done for the year, the question lingers.  What are the odds the IRS will put you on the “A” list –  as in to be audited?   Last week, the IRS released its tally sheet of who was audited in their 2010 fiscal year.  In general  the rates were up.  Also generally, the recipients of additional IRS attention were the usual suspects:  individuals with income between $200,000 and $1 million, businesses with gross receipts of more than $25,000 and individuals claiming the earned income credit.  Higher income puts you at the top of the class.  Corporations with assets of $100 million or more had a 14.5% chance of an audit, vs. those with $250,000 to $1 million at a 1.3% chance of getting a notice.  Give the IRS some credit; they go where the money is.

So if those are the odds you’ll be investigated, what are the chances it’ll cost you?  According to the  data book, the IRS assessed financial penalties against 27.1 million individuals last year.  More than half of those were for failure to pay tax.  Only a little more than 1.1 million businesses suffered the same fate, with 42% of the assessments related to failure to pay.  If the IRS decides to look at criminal investigations, the numbers get more serious.  Of the roughly 3,000 cases referred for prosecution, more than 2,000 resulted in conviction.  Almost 82% of those convicted were incarcerated (home confinement with an electronic bracelet is included in those numbers.)  Don’t say I didn’t warn you.

Speaking of warnings, the IRS does have a special program started in 2010 to audit businesses for payroll taxes.  (For more detailed discussions about the program specifics, you can go to my post “Going Where the Money Is”).  Word is the issue they’re most focused on for these audits is whether employees are properly classified as “employees” or "independent contractors”.    While at a high level the idea of someone who has more discretion on how the work gets done is usually contractor material, there are lots of grey areas.  For sure you don’t want the IRS discussing the topic with you.  It’s worth asking a trusted advisor who knows about this type of thing if you are operating in shades of grey.  If so – move into black and white territory as fast as you can.   It’ll beat wearing an orange jumpsuit. 

Going Where the Money Is

Even if you’ve not been impacted by Justice Department’s investigation of insider trading, here’s a new potential notice to worry about.  The IRS is in the process of launching it’s Employment Tax National Research Project.   The research plan is to audit 6,000 companies selected at random on the general topic of the compliance characteristics of employment tax filers.  In case you’re wondering why this is a priority, the taxes collected through employers come to $1.7 trillion a year.  This is almost 72% of the annual revenue of the US treasury.   So yes,  it appears the study is worth doing “because that’s where the money is” .

The first 2,000 “lucky” companies have gotten their audit notices already.   This will be an annual event for the next two years, so you still may be selected.  The stated goal of the study sound reasonable.  The IRS estimates a “tax gap”, which they define as the difference between the amounts taxpayers should pay and what they actually send in as payment.  The IRS typically targets audits hoping to reduce this tax gap.  There is a concern that in the 25 years since the IRS last looked at likely causes of “tax gap” associated with employment taxes much has changed in how companies process these payments.  So the first goal is to determine if current estimates of this tax gap on target, and then, perhaps more importantly to figure out what areas of employment tax lead to the most compliance problems. 

While the agency indicates that the audits are going to be comprehensive, there are apparently four areas that will be targeted for scrutiny:  worker classification (this goes to the question of whether you’re an employee or contractor), executive compensation, fringe benefits and payroll taxes.  According to the Thompson Bulletin, law-abiding companies who are included in these random samples will have to provide significant amounts of information and will need to allocate specific resources to meet the IRS requirements for data.   Compliance Week  passes on the following:

  In its alert to employers the IRS advises companies to plan their response carefully should they receive a letter initiating an audit under the research program. The IRS says companies should form an internal team consisting of representatives from payroll, accounts payable, accounting, human resources, internal auditing, general counsel, and outside tax professionals.

If you’re not getting scrutiny on this topic now, it’s worthwhile to add doing some internal due diligence on the area of employment tax compliance as a New Year’s resolution.   Better to catch your issues yourself rather than have the IRS do it for you.