Companies have been bombarded: the Patient Protection and Affordable Care Act, the Wall Street Reform and Consumer Protection Act, the Tax Relief and Health Care Act, and the Small Business Jobs Act. It’s enough to make the most sophisticated of professionals want to run for cover. This edition of Tax Advisor Weekly shines some light on employment tax issues to keep on your radar for 2011.
In December 2009, the Internal Revenue Service quietly announced the Employment Tax National Research Project (ETNRP), scheduled to begin in early 2010. In a simple press release, the IRS revealed that it would audit the employment tax practices of 6,000 employers over a three-year period (2010 to 2012). Its stated objectives were to: (i) obtain information for computing the employment tax gap; and (ii) determine compliance characteristics with existing employment tax requirements so it could focus on the areas with the most compliance problems. Presumably, success on objective No. 2 would help with closing the tax gap being estimated in objective No. 1.
The IRS is reported to be selecting companies at random, but focusing on smaller employers in select industries. In February 2010, the IRS began contacting approximately 2,000 employers. It is expected to focus its investigation on worker classification, fringe benefits, executive compensation and payroll taxes. We anticipate that once its review is complete, the IRS will begin targeted employment tax audits.
In August 2009, the U.S. Government Accountability Office issued a report on worker misclassification indicating that there was lost revenue in employment taxes and unemployment tax revenue. The GAO recommended greater focus on this issue, and the ETNRP appears to be a response to this order.
The IRS will be looking with great interest at how companies treat fringe benefits, both taxable and non-taxable, and whether they are being properly valued. Non-taxable fringe benefits include, but are not limited to, working condition fringes, de minimis fringes, no-additional-cost services, qualified employee discounts, qualified moving expenses and qualified transportation fringe benefits. Taxable fringe benefits include, but are not limited to, spousal travel, gift cards, company-provided automobiles, country club dues and housing benefits.
The IRS will also focus on executive compensation programs and their compliance with Internal Revenue Code sections 409A and 162(m). Notice 2010-6 set forth ways that certain plan documents that do not comply with the form requirements of 409A can be amended and escape the harsh penalties for non-compliance (a 20 percent excise tax, income inclusion and interest). For more on this notice, see
While the deadline for this consequences-free relief has passed for most failures, Notice 2010-80, issued in late 2010, provides some additional relief for certain failures through December 31, 2012. At any rate, these notices still provide relief from the excise tax if certain requirements are met.
The timeliness of the remittance of payroll taxes will also be examined, as will backup withholding requirements and determining whether all appropriate items of income have been subjected to employment taxes.
While the IRS uncovers new employment tax gaps through the ETNRP, it has already issued several new measures to tackle previously exposed tax gaps.
The Initial Attack
In late March 2010, President Obama signed into law the Patient Protection and Affordable Care Act of 2010. The health care reform legislation includes a hidden gem of a provision: effective January 1, 2012, it will require that an information return be provided by every person engaged in a trade or business that makes payments aggregating $600 or more in any taxable year to a single payee. The kicker? The payments to be reported include amounts paid for services or property. This would require businesses to issue Form 1099s not only to independent contractors, but also to any person, company or entity from whom they purchased more than $600 in goods or services.
Signs of Retreat
In August 2010, the IRS provided some relief from these 1099 requirements by eliminating duplicative reporting of the same transaction. A business owner engaged in these qualifying transactions will be exempt from information reporting if payment is made using a payment card instead of via cash or check. The payment settlement organizations will bear the responsibility of providing information returns for these purchases.
While this provides some relief to business owners, there is talk of repealing the new 1099 mandate altogether. On February 2, 2011, the Senate approved an amendment to the FAA Air Transportation Modernization and Safety Improvement Act that repeals the 1099 reporting requirement, but the House did not take up the Senate’s legislation. Instead, on March 3, 2011, the House passed its own version of repeal through the Small Business Paperwork Mandate Elimination Act. While there is undeniably bipartisan support for repeal, there is much debate on how to recoup the $22 billion that would be lost. We may see many more versions of a repeal before we can declare a decisive victory for small businesses.
And the Hits Just Keep Coming
President Obama signed into law the Small Business Jobs Act of 2010 on September 27, 2010. It contained a provision that, effective January 1, 2011, increases the penalty amounts for failure to timely file an information return with the IRS and failure to furnish payees with a correct information statement (to employees as a Form W-2 and to non-employees as a Form 1099).
Also completely new is a provision that will now index the penalty amounts for cost of living increases.
Reporting Up the Chain of Command
In case you didn’t have enough to keep you busy, there are new reporting requirements effective for the 2010 tax year relating to Incentive Stock Options (ISOs) and Employee Stock Purchase Plans (ESPPs). All companies that use ISOs or ESPPs must file with the IRS (and provide copies of the forms to employees) forms 3921 and 3922 to the extent that there are ISO exercises (whether or not held post-exercise or disqualified through disposition) or ESPP transactions during the year. The forms are to be filed with the IRS in either paper or electronic form by February 28 or March 31, respectively, and the information statements must be delivered to affected employees by January 31. Failure to file with the IRS or provide copies to employees can result in substantial penalties from the IRS.
Employers Must Mobilize Their Troops
How should companies prepare for the onslaught?
- Review nonqualified deferred compensation arrangements to make sure they comply with 409A. Any noncompliant plan document provisions should be corrected.
- Prepare for an employment tax audit.
- Conduct an internal audit of benefits provided to employees and executives, and confirm how they are treated from a tax perspective and how any taxable benefits are valued. Correct any identified errors going forward and determine the best way to fix errors that have already occurred.
- Review the status of every employee and independent contractor to make sure that no one is misclassified. Update (or adopt) processes and procedures around worker classification.
- Review Form 941s and other tax-related documents to make sure the company complies with the relevant reporting requirements.
- Get your 1099 house in order.
- The new, higher penalty amounts will be in play for 2011, so make sure you are properly reporting income for your workforce. Conduct an internal review to make sure nothing falls through the cracks, because it’s about to get a lot more expensive if it does.
- If no repeal passes, beginning in 2012, companies will have to issue 1099s for all vendors to whom it pays more than $600 in goods and services via cash or check. Companies need to identify which departments could be affected, determine the best way to capture the information necessary for accurate and timely reporting, and implement processes and procedures that will ensure compliance.
- Ensure records of all ESPP and ISO awards are up to date and contain the information needed to satisfy the new filing requirements.
- Track down equity reporting information.
Alvarez & Marsal Taxand Says:
If you are lucky enough to dodge the Employment Tax National Research Project, don’t get too excited just yet. The IRS will be using information gathered during this three-year project to more effectively target companies to audit in the future. Don’t get ambushed: perform an internal review and ensure you are employing best practices.
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The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
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