The IRS’ “Employment Tax Research Project” has identified four main areas of payroll errors: worker misclassification, fringe benefits, executive compensation and payroll taxes. Given that they put this research project together, and the IRS’s increased attention towards employment taxes, we recommend that companies (at a minimum) look at how they handle some of the potential payroll complications identified by the study. Here are a few of the common errors that we have seen companies make and while this list is not exhaustive, it does provide a jumping off point for determining how well your company is doing. We recommend that Companies conduct what is known as a “compliance review” while they still have a chance to fix what's wrong without having to negotiate penalties and interest with an IRS auditor at the same time.
1. Classification of employees as independent contractors.
a. Form W-2 verses Form 1099
b. In case of an error the IRS has a Voluntary Classification Settlement Program which allows eligible employers to voluntarily reclassify workers as employees on a prospective basis and get into compliance by paying 10% of the employment tax liability that may have been due on incorrectly classified workers for the most recent tax year.
2. Failure to subject vendor payments to backup withholding
a. Ask your vendors to fill out Form W-9
b. If a vendor does not supply a company with a tax identification number that should supply one, backup withholding of 28% is mandatory.
3. Failure to issue Form 1099s
a. Form 1099 should be issued to most vendors who are paid $600 or more for services during the calendar year.
b. Failure to issue Form 1099 can be subject to penalties.
4. Not including the Fair Market Value of gift cards, prizes and awards in employees’ income
a. Most employment prizes and awards are considered taxable fringe benefits subject to income and employment taxes. Gift cards are equivalent to cash for this purpose and are always taxable.
b. Certain items can be excluded from wages if they are de minimis in nature. Cash and cash equivalents are never de minimis.
5. Failing to timely deposit withheld taxes
a. Check the deposit frequency rules and make certain you comply.
b. Penalties range from 2% to 15% depending on how late the deposit is made.
6. Incorrectly excluding expense reimbursements from reportable wages
a. Expenses paid under an Accountable Plan can be excluded from an employee’s compensation, but expenses paid to an employee outside an Accountable Plan are not excluded.
7. Not including the appropriate value of taxable fringe benefits in employees’ income
a. Some fringe benefits are specifically excluded from tax but the rest are taxable compensation to the employee who receives the benefit.
b. Spousal travel; company-provided automobile; country club dues; housing benefits are examples of taxable fringe benefits.
c. Calculating the value of these fringe benefits can be complicated.
8. Excluding travel and commuting expense reimbursements from employees’ incomes
a. Most of the time, travel and commuting expenses are not taxable income to an employee. But if what started out as a short-term assignment is extended beyone a year, or if an employee is traveling to a permanent work site that is not in the same place as his or her permanent residence, those company-provided commuting benefits may need to be included in the employee’s income
Jeremiah K. Murphy, CPA is an accounting firm providing tax services, audits and business consulting.