The Nuts and Bolts of Payroll Taxes in New Jersey

Paul Dougherty, CPA, MST, J.D.

AGENDA

    Definition of employee Independent contractors How to deal with the IRS Questions

Who Is an Employee?

A.

B.

C.

Statutory Employees Independent Contractor vs. Employees Statutory Nonemployees

Statutory Employees

Workers engaged in the following occupations are considered to be employees by statute for social security tax purposes, and in some cases for FUTA tax purposes (if certain requirement are met): 1.

Officers of corporations; 2.

Agent-drivers and commission-drivers; 3.

4.

5.

Full-time life insurance sales person; Homeworker; and Traveling and city salespersons.

Officers of a Corporation

 An officer of a corporation is generally an employee. This is the case even if the duties are performed on a part-time basis. However, an officer who does not perform any services as an officer or performs only minor services is not considered an employee if he neither receives nor is entitled to receive any remuneration, directly or indirectly.

Statutory Non-Employees

 Qualified real estate agents and direct sellers are treated as self-employed if substantially all their income is from sales and they work under contract providing that they are self-employed for federal tax purposes.

Qualified Real Estate Agents

 “Qualified real estate agents” are defined as licensed real estate agents, substantially all of whose remuneration is directly related to sales or other output and who perform services pursuant to written contracts that specifies that they will be treated as self-employed.

Employee vs. Independent Contractor

 Compensation paid to workers is subject to federal employment taxes (FITW, Social Security, and FUTA taxes) only if the workers are considered to be employees.  Compensation paid to independent contractors is not subject to the three employment taxes.

The Common-Law Test for Employee Vs. Independent Contractor Status

An individual is employee of person for whom he performs services if a common-law employer-employee relationship exists between parties. Under common-law test, an individual is an employee if individual is under direction and control of party for whom services are being performed.

The following is a list of the 20 factors used in common-law tests:

1.

2.

3.

4.

5.

6.

7.

8.

Compliance with instructions Training Integration with business Personal rendition of service Hiring, supervising, and payment of assistants The existence of a continuing relationship Set hours of work Exclusive full-time work 9.

Work on employer’s premises 10.

Sequence of work done

The following is a list of the 20 factors used in common-law tests (continued):

11.

12.

13.

14.

15.

16.

17.

18.

19.

20.

Report required Payments by hour, week, or month Expense account Tools and material supplied Facilities furnished Risk of Loss Number of “employees Availability to general public Power to fire Termination damages

Save Haven Rule

 A safe haven rule minimizes the uncertainty of employers in determining whether workers are employees or independent contractors.

 This rule relieves taxpayers of potential liabilities based on employment tax status reclassification.

Safe Haven Rule

Under the safe haven rule, a worker will not be treated as an employee if (1) a consistency requirement is met under which: (a) the worker and similarly situated employees must not have been treated as employees for any period beginning after 1977 and (b) the employee taxpayer did not file the applicable federal employment tax returns (including information returns) that would ordinarily be filed with respect to the worker if her were an independent contractor, and (2) the employer had a reasonable basis for not treating the worker as an employee.

Common-Law Test in Particular Occupations

 Application of common-law factors to any particular job situation to determine employee/independent contractor status is an inexact process by which special characteristics peculiar to each job are weighed against general rules.

Common-Law Test in Particular Occupations

Insurance Agents  An insurance company branch broker-manager is an employee under the common-law test where he is subject to detailed supervision and control over the manner in which he performs his services. If certain factors are not present, the branch manager is considered an independent contractor and his compensation is not subject to the federal employment tax laws (SS, FUTA, & FITW).

Common-Law Test in Particular Occupations

Salesperson and Broker  The status of certain salespersons is determined by statute. Salespersons who qualify as full-time traveling or city salespersons are employees; qualified real estate agents and direct sellers are considered self-employed.

 If a salesperson does not meet any of the above definitions, that person’s status is determined under the common-law test. The term “salesperson” embraces a wide variety of occupations; the particular factors that are important in determining an individual’s status vary accordingly.

How to Deal With the IRS

A.

How to Request a Ruling From the IRS B.

Audit Triggers C.

How to Handle an Audit D.

Trust Fund Recovery Penalty

How to Request a Ruling From the IRS

 A taxpayer can apply to the IRS Associate office for a ruling regarding tax consequences of specific set of facts proposed by taxpayer.  A ruling will generally not be issued if the taxpayer’s return is under audit but IRS may issue technical advice on the matter.  A taxpayer may also obtain information or determination letters from local IRS offices if issue upon which advice is requested relates to clearly established principal of tax law.

How to Request a Ruling from the IRS (continued)

 Where a taxpayer is not under audit and desires information as to his tax status, he can make inquiries or requests to the Director of the appropriate functional unit of the IRS who can issue information or determination letters by applying the statutes and tax treaties, regulations, revenue rulings, and other precedents published in the Internal Revenue Bulletins.

 An actual ruling can only be issued by the Associate Office.

Revenue Rulings

 The IRS uses it’s revenue ruling program as a method of disseminating interpretations of the statute and regulations which are of interest to taxpayers in general.

 Revenue rulings are carefully reviewed before being published because they may be used as precedent in other cases where the facts or issues are the same.

Audit Triggers

 There is only a small classification and selection program for employment tax returns. In many cases, employment tax returns are examined only as adjunct to income tax or exempt organization return audits.

 The IRS devises an audit strategy for each type of tax return. The percentage of returns selected for audit in each category of tax return, called the “audit selection rate” for that return category, depends on the sheer numbers of returns filed in that return class and on the IRS allocation of audit man-hours.

Audit Triggers (continued)

 The biggest allocation of resources is devoted to individual income tax returns, where the selection rate is fairly low (0.77%) but where over 90% of all audits were conducted for calendar year 2003.

 The next two most important targets of the IRS audit program are estate tax returns and corporate returns.

 The audit selection rate for employment tax returns Forms 940 through 943 has never exceeded 1% in the last five years.

Audit Triggers (continued)

There are three areas of IRS concern in the field of employment tax examinations  First, taxpayers who have not filed  Second, an item on a return which increases the chances of audit. This area involves employee fringe benefits as they affect the wage base on which social security and FUTA taxes are computed.

 Third, misclassification of employees as independent contractors.

How to Handle an Audit

 How an employer handles audit of his employment tax return depends on the type of audit that takes place and where it takes place.

 By being aware of the issues that are likely to be raised during the course of an audit, the employer and his tax representative can take steps to reduce the likelihood that an in-depth employment tax examination will take place in conjunction with the taxpayer’s income tax or exempt organization return.

Types of Employment Tax Examinations

The Large Case Audit  This program was designed to deal with increasingly large and diversified business entities with complicated organizational structures and business practices, and with plants, divisions and subsidiaries located across the nation and in many foreign countries.

The Package Audit  Agents and auditors assigned to office or field audits of income tax cases have been trained to be aware of possible employment tax issues that may arise in conjunction with the audit of corporate, exempt organization, and individual business returns.

How Thoroughly Will the Return Be Examined?

 The degree to which an employment tax return will be scrutinized depends on time constraints as well as the employment tax expertise of the examining agent or auditor.

 An office audit of an individual’s tax return is handled by an agent who generally has received less training in employment tax issues.

 A field examination in the employer’s office is conducted by an agent who has had substantially more training in employment tax issues.

When is the Employer Safe from Additional Tax Assessments?

 The IRS has three years after the filing of a tax return to issue a deficiency notice or to assess penalties and taxes in addition to those shown on the return. However, if the return is filed prior to its original due date, then the three year period runs from the date the return is due, not the date the return is actually filed.

 There are some exceptions to the three-year time limit, such as fraud.

 The IRS may seek the taxpayer’s consent to extend the three-year limit to allow it more time to complete an audit (Form SS-10).

Preparing for the Audit

 First, decide whether the audit will be handled by the taxpayer or the taxpayer’s representative (Tax attorney, CPA or both).

 Second, when and where will the audit take place  Third, gather together all the payroll records pertaining to the year or years being audited. This includes any workpapers used in the preparation of the return.

Handling the Actual Audit

 As the audit progresses, the taxpayer should keep in mind that the burden is on him to prove he has paid the proper amount of tax.

 The auditor should be allowed to complete his audit before there is any discussion of specific items.

 Cooperation with the agent will, in the typical case, bring the audit to a speedy and satisfactory conclusion.

Trust Fund Recovery Penalty

 If the employer fails to withhold the proper amount of FITW, he remains liable for the unpaid amount.

 An individual in the employing firm who is responsible for the collection and payment of withholding taxes may be held personally liable for a penalty of 100% of the unpaid taxes if income taxes and social security taxes are not withheld or if the withheld taxes are not paid to the IRS.

 In 1993, the IRS relaxed the definition of a responsible person and strengthened the procedures that IRS agents must follow before the penalty can be assessed.

“The material contained in this presentation is for general information and should not be acted upon without prior professional consultation.”