The IRS's National Research Program (NRP) isn't as benign as it sounds. NRPs are intensive, line-by-line audits, which are intended to give the IRS baseline compliance data for future enforcement efforts. The Payroll NRP, which will be conducted by the IRS's Small Business/Self-Employed Division, was scheduled to start last November, but actually will begin this month. The NRP will randomly target 2,000 Forms 941 a year for three years, and will sweep across all business organizations, large and small, for profit and not-for-profit. Are you confident your Forms 941 will pass NRP muster?
Areas of concentration. Audits will likely encompass examinations of tax year 2007 and 2008 Forms 941 and 1099. Auditors will be looking at worker classification,, expense reimbursement plans, officer compensation, and non-filers. However, auditors aren't bound by these five items, and can go wherever your data lead them. Here's an overview of these subjects.
Worker classification. Independent contractors should achieve the result for which they were hired; you shouldn't be concerned with how they went about it. Requiring them to be present in your workplace, for example, could show that you had the right to control their work (of course, there are many indicators of the right to control). And it's the right to control that's the key to determining whether an independent contractor is really an employee.
Fringe benefits. Some fringes, such as self-insured medical plans, dependent care assistance, educational assistance, product testing, and employee discounts, have non-discrimination requirements that prevent you from providing greater benefits to upper. If the non-discrimination requirements aren't met, managers have taxable income; the benefits for rank-and-file employees remain tax-free. Dependent care and educational assistance have annual monetary limits — $5,000 and $5,250 respectively.
Expense reimbursement plans. Business expense reimbursement plans must be accountable plans. Under the accountable plan rules, employees must pay or incur deductible expenses (i.e., there's a business connection), they must submit receipts and other substantiation to you for those expenses within a reasonable period of time, and they must return excess reimbursements or allowances to you within a reasonable period of time. If the IRS determines that your plan is a non-accountable plan and is abusive, it can disqualify the entire plan. Result: All reimbursements become taxable.
Officer compensation. Corporate deductions for officer compensation are limited to reasonable amounts. For example, it's plainly unreasonable for physicians to pay themselves $2,000 a year in salary. For S corps, the issue is whether officers take large non-FICA-taxable distributions and small FICA-taxable salaries. S corp owners, therefore, should be paid a reasonable FICA-taxable salary before they take distributions. The order in which payments are made is critical, and easy for the IRS to detect, since wages are reported quarterly and distributions are reported annually.
What To Do If Your're Tapped: The IRS kicks off an audit with an information document request (IDR). As its name suggests, an IDR asks for appropriate documents — corporate minutes, copies of tax returns, books of account, etc. To speed the process along, ensure that payroll forms are organized, collated, and coordinated with documentation that backs up entries on them. Also ensure that your 941s are reconciled to the general ledger. Totals must agree. If there's an error, be sure that there's a later record correcting that error. To facilitate the audit, appoint an Audit Controller. This person is the company's tax expert and the liaison for all documents and communications between the company and the auditors.
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