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IRS Employment Tax Audits.
When IRS audits a business and especially companies for payroll tax audits they use the following factors. They will apply these factors and use them for the purpose of obtaining the information they need during the tax audit.
If you are involved in this type of employment tax audit you need to have professional tax help because IRS can make is very difficult on you.
Common Law Rules for Employment Tax Audits
Facts that provide evidence of the degree of control and independence fall into three categories:
1. Behavioral:
Does the company control or have the right to control what the worker does and how the worker does his or her job?
2. Financial:
Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of Relationship:
Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor.
Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor.
There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination.Generally, an IRS agent will look on the preponderance of evidence.
Also, factors which are relevant in one situation may not be relevant in another.
The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document e
Behavioral control refers to facts that show whether there is a right to direct or control how the worker does the work.
A worker is an employee when the business has the right to direct and control the worker. The business does not have to actually direct or control the way the work is done – as long as the employer has the right to direct and control the work.
The behavioral control factors fall into the categories of:
• Type of instructions given
• Degree of instruction
• Evaluation systems
• Training
Types of Instructions Given
An employee is generally subject to the business’s instructions about when, where, and how to work.
All of the following are examples of types of instructions about how to do work.
• When and where to do the work.
• What tools or equipment to use.
• What workers to hire or to assist with the work.
• Where to purchase supplies and services.
• What work must be performed by a specified individual.
• What order or sequence to follow when performing the work.
Degree of Instruction
Degree of Instruction means that the more detailed the instructions, the more control the business exercises over the worker.
More detailed instructions indicate that the worker is an employee.
Less detailed instructions reflects less control, indicating that the worker is more likely an independent contractor.
Note: The amount of instruction needed varies among different jobs. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved.
A business may lack the knowledge to instruct some highly specialized professionals; in other cases, the task may require little or no instruction. T
he key consideration is whether the business has retained the right to control the details of a worker’s performance or instead has given up that right.
Evaluation System
If the evaluation system measures just the end result, then this can point to either an independent contractor or an employee.
Training
If the business provides the worker with training on how to do the job, this indicates that the business wants the job done in a particular way.
This is strong evidence that the worker is an employee.
Periodic or on-going training about procedures and methods is even stronger evidence of an employer-employee relationship. However, independent contractors ordinarily use their own methods.
Financial control refers to facts that show whether or not the business has the right to control the economic aspects of the worker’s job.
The financial control factors fall into the categories of:
• Significant investment
• Unreimbursed expenses
• Opportunity for profit or loss
• Services available to the market
• Method of payment
Significant investment
An independent contractor often has a significant investment in the equipment he or she uses in working for someone else.
However, in many occupations, such as construction, workers spend thousands of dollars on the tools and equipment they use and are still considered to be employees.
There are no precise dollar limits that must be met in order to have a significant investment.
Furthermore, a significant investment is not necessary for independent contractor status as some types of work simply do not require large expenditures.
Unreimbursed expenses
Independent contractors are more likely to have unreimbursed expenses than are employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important.
However, employees may also incur unreimbursed expenses in connection with the services that they perform for their business.
Opportunity for profit or loss
The opportunity to make a profit or loss is another important factor. If a worker has a significant investment in the tools and equipment used and if the worker has unreimbursed expenses, the worker has a greater opportunity to lose money (i.e., their expenses will exceed their income from the work).
Having the possibility of incurring a loss indicates that the worker is an independent contractor.
Services available to the market
An independent contractor is generally free to seek out business opportunities. Independent contractors often advertise, maintain a visible business location, and are available to work in the relevant market.
Method of payment
An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. This usually indicates that a worker is an employee, even when the wage or salary is supplemented by a commission. An independent contractor is usually paid by a flat fee for the job. However, it is common in some professions, such as law, to pay independent contractors hourly.
Type of relationship refers to facts that show how the worker and business perceive their relationship to each other.
The factors, for the type of relationship between two parties, generally fall into the categories of:
• Written contracts
• Employee benefits
• Permanency of the relationship
• Services provided as key activity of the business
Written Contracts
Although a contract may state that the worker is an employee or an independent contractor, this is not sufficient to determine the worker’s status.
The IRS is not required to follow a contract stating that the worker is an independent contractor, responsible for paying his or her own self employment tax.
How the parties work together determines whether the worker is an employee or an independent contractor.
Employee Benefits
Employee benefits include things like insurance, pension plans, paid vacation, sick days, and disability insurance.
Businesses generally do not grant these benefits to independent contractors. However, the lack of these types of benefits does not necessarily mean the worker is an independent contractor.
Permanency of the Relationship
If you hire a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that the intent was to create an employer-employee relationship.
Services Provided as Key Activity of the Business
If a worker provides services that are a key aspect of the business, it is more likely that the business will have the right to direct and control his or her activities.
For example, if a law firm hires an attorney, it is likely that it will present the attorney’s work as its own and would have the right to control or direct that work. This would indicate an employer-employee relationship.
While the above list is not comprehensive is a good indication of how the Internal Revenue Service will view your case.
Call us today for free initial tax consultation. We are true experts if you need help for IRS employment tax audits.
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