Employment tax audits can happen to any business at any time. The good news is that proactive measures can be taken to lessen the likelihood of an audit, limit the audit to a compliance check, and protect yourself and your business from financial and criminal penalties. However, it’s essential to acknowledge that your company can still find itself in the audit spotlight.
The landscape is evolving, with the IRS currently training a substantial number of new auditors under the Inflation Reduction Act (IRA), hinting at increased auditing activity on the horizon. Should your business be selected for an audit, the IRS typically initiates the process with a review of your federal employment tax forms and a brief interview—a preliminary step known as a compliance check.
If the auditor is satisfied with your business’s compliance during this initial check, it may conclude the audit there. However, if lingering questions remain, the audit may progress into a comprehensive examination of your corporate books and records, known as a full audit. Beyond scrutinizing employee tax withholding records, a full audit might delve into worker classification, the Trust Fund Recovery Penalty (TFRP), officer compensation, and various other potential issues. In the following sections, we’ll unravel some of these tax audit triggers.
Navigating Withholding Tax Compliance
Employers are required to withhold employment taxes from their employees. You should make certain you are compliant with your withholding obligations and that your records are clear. Your records should include a comprehensive breakdown of amounts paid, federal (and, if applicable, state) withholdings, Medicare and Social Security taxes withheld, and any penalties and interest that may be assessed. Furthermore, clarity in your records regarding cafeteria plans, fringe benefits, and other payroll-related matters is essential to steer clear of employment tax audit pitfalls.
Worker Classification: The FLSA Final Rule Impact
The Department of Labor’s recent announcement on January 9th, 2024, brought about a significant shift in the determination of worker classification under the Fair Labor Standards Act (FLSA). This rule aims to clarify when a worker should be categorized as an employee or an independent contractor. The government’s decision to rescind the 2021 independent contractor rule suggests an impending emphasis on this issue. Understanding and adapting to these changes is crucial to safeguard your business from potential employment tax audit risks.
Trust Fund Recovery Penalty (TFRP)
Because you, as the employer, hold the employee’s withholding money in trust until you release it as a federal tax deposit, Congress passed the TFRP law to try to ensure prompt payment of withheld income and employment taxes, including social security, railroad retirement, and collected excise taxes. If you do not make sure these taxes can be immediately collected from your business, you risk assessment of the TFRP, a factor that can trigger an employment tax audit.
Officer Compensation: Striking the Right Balance
Wages paid to an officer of a corporation should generally be commensurate with the officer’s duties. If the IRS judges the officer to be underpaid, it may require adjustments be made to the income and expenses of tax returns for both the officer and the corporation.
Unemployment Tax Forms
Unemployment tax forms are used to report and pay unemployment taxes to the government. Employers are required to file these forms to ensure compliance with state and federal regulations. When an employer operates in multiple states, they may be eligible to take a credit for payments made to other states. However, if the employer does not have the necessary certification from the states, the IRS may deny or ignore the credits, and the employer could be held liable for the full amount owed.
That is why it is so important for employers to ensure that they have the required certifications from each state to avoid potential denial of credits by the IRS and to comply with state regulations regarding unemployment tax payments and credits.
Facing an Employment Tax Audit?
You’ve likely worked diligently alongside your accountant to ensure your business remains in compliance and avoids any unwanted encounters with the IRS. However, if you do find your business facing the prospect of an employment tax audit, Kundra & Associates has been a trusted source of guidance for over 30 years. Serving clients in Bethesda, Arlington, Rockville, Alexandria, and Washington D.C., as well as around the world, our expertise lies in providing clear and effective advice on policies and procedures aimed at shielding your business from the potential adverse consequences of employment tax audits. If you’re seeking to leverage our wealth of experience and knowledge, please feel free to get in touch with us online or give us a call at 301-597-4975.
