Employment Tax Audits

CPA Journal, The, Apr 2008 by MacDonnell, G J Stillson, Weissman, William Hays

* Understand the relationship between the workers and the business. Understanding the relationship between a worker and a business is critical in a worker classification review and allows a representative to persuasively discuss the taxpayer's position with the auditor. For example, it is important to know what types of restrictions the client placed on the time and place that services were performed, whether there is a written contract, whether the client monitored or evaluated the employees, and so on.

* Contest state benefits cases. Because many state employment tax audits result from obstructed claims, it can sometimes be important to contest a worker's claim for benefits. A finding by an agency that a worker is not an employee can sometimes prevent or derail an audit of worker classification issues for the business generally, or can at least provide the business with a strong defense.

* Evaluate the use of IRC section 530 whenever possible for federal worker classification audits. IRC section 530 (created by the Revenue Act of 1978) is a safe harbor provision that prevents the 1RS from retroactively reclassifying workers. It can relieve an employer of liability for federal employment taxes, penalties, and interest associated with a misclassification under common law. In any federal worker classification audit, IRC section 530 should be the starting point of the review. The requirements for meeting section 530 are explained in detail in the 1RS publication "Independent Contractor or Employer? Training Materials" [Training 3320-102 (October 30, 1996)], available on the 1RS website (www.irs.gov). If an employer has a strong position under IRC section 530, this may quickly resolve any status audit.

Be Prepared

The key to success in any unemployment tax audit is preparation. Accountants should know the details so that you can persuasively explain them to the IRS auditor. While the auditor may be friendly, he is not the taxpayer's friend. Care should be taken when providing any information to the IRS. While no single strategy can work in every audit, the strategies outlined above provide a good framework for handling any employment tax audit.

G.J. Stillson MacDonnett is a shareholder and chair of the employment taxes practice group at Littler Mendelson, P.C., a national employment and labor law firm. William Hays Weissman is a shareholder in the employment taxes practice group of Littler Mendelson, P.C. The authors can be contacted at gjmacdonnell@littler.com and wweissman@littler.com.