Employers: Get Your Ducks In A Row!

Just received this in my inbox from the Texas Society of CPA's:

IRS and Employers Gear Up for Employment Tax Audits
October 9, 2009 – The Internal Revenue Service has announced plans to launch employment tax audits this fall in conjunction with its National Research Program (NRP). NRP audits are intensive audits followed by analysis. While it is expected that the audits will result in tax assessments, the underlying purpose of the audits is to collect data that will be used in designing profiles for future audits.

A random selection of approximately 6,000 employers will result in the audit class for this project. Employers will be chosen across a broad statistical platform and will include large, medium, and small businesses, for profit, and not-for-profit businesses.

Issues to be considered in these audits include classification of employees v. independent contractors, classification of fringe benefits, reimbursement of expenses, comparison of employee and independent contractor records to actual tax return filings by the recipients, and officer compensation.

Accountable plans for reimbursement of expenses will be examined in the audits. Such plans will be expected to demonstrate that there is a business connection for the expenses, the expenses are reasonable, there is reasonable accounting for the expenses, and reimbursements are paid in a reasonable amount of time.

Auditors will look at withholding and remittance of income taxes, Social Security and Medicare taxes, and unemployment taxes. Employer-prepared payroll tax forms and related deposits will also be examined for accuracy and timeliness.

The audits are expected to begin in November, 2009 and will be conducted over a three year period. Typical audits will cover three years of employment tax records.

S Corporation Shareholder/Employees and Social Security

One of the benefits of an S corporation is the flow through aspect of the income for tax purposes. S corporations do not have their own tax liability; the income simply flows through to the shareholder's individual income tax return. Even though the IRS says that S corporation shareholders who provide services to the company should pay themselves a "reasonable" salary, the shareholder/employees will often keep that salary to a minimum in order to avoid incurring Social Security and Medicare taxes, and take the rest of the funds they need as dividends/distributions of previously taxed income.

Young S corporation shareholders are particularly against paying into the Social Security system because they are of the opinion that by the time they retire, Social Security will be no more. What they do not realize is that the Social Security system is not only for retirement. It also provides disability and survivors benefits. Heaven forbid anything happen to that person, but if it does, Social Security benefits are made available to that person upon disability or to his/her survivors upon death. In the latter scenario, Social Security acts almost like a life insurance policy. Something to think about before you decide to set that low salary as an S corporation shareholder/employee. Not only will you possibly attract the scrutiny of the IRS for an unreasonable salary, you might also be short-changing your family, especially if you aren't sufficiently covered in the private market for disability or life insurance.

For more information about Social Security benefits, you may visit www.ssa.gov