Jeffrey B. Kahn, Esq. Discusses IRS Payroll Tax Audits & Issues On ESPN Radio – November 14, 2014 Show

Topics Covered:

1. Jade’s Story Of Her IRS Audit
2. Would Your Business Survive an IRS Worker Classification Audit?
3. When Payroll Taxes Pyramid It Means Penalties, Even Jail
4. Questions from our listeners:

• What is the new maximum wage amount in 2015 that would be subject to a total Social Security FICA tax of 12.4%?
• What is the regular Medicare Tax that applies to compensation?
• What is the new additional Medicare Tax that came into place?
• When does the new additional Medicare Tax get reported and paid?
• What payroll tax liabilities of my business could I be personally liable for?

Yes we are all working for the tax man!

Good afternoon! Welcome to the KahnTaxLaw Radio Show

This is your host Board Certified Tax Attorney, Jeffrey B. Kahn, the principal attorney of the Law Offices Of Jeffrey B. Kahn, P.C. and head of the KahnTaxLaw team.

You are listening to my weekly radio show where we talk everything about taxes from the ESPN 1700 AM Studio in San Diego, California.

When it comes to knowing tax laws and paying taxes, let’s face it — everyone in the U.S. is either in tax trouble, on their way to tax trouble, or trying to avoid tax trouble!

It is my objective to make you smarter so that you legally pay the least tax as possible, avoid tax problems and be aware of the strategies and solutions if you are being targeted by the IRS or any State tax agency.

Our show is broadcasted each Friday at 2:00PM Pacific Time and replays are available on demand by logging into our website at www.kahntaxlaw.com.

I have a lot to cover today in the world of taxes and helping me out today will be my associate attorney Amy Spivey who will be calling in later in today’s show.

So the big question today is if the IRS asked to examine your business’ Federal Tax returns, would you survive the audit? For Jade Phuong who operates a nail salon, it was a nightmare that came very close to ending her business.

Jade’s Story.

Before the IRS turned her world upside down, Jade already had beaten the odds as a small-business owner. Her name salon had been operating more than eight years, a considerable accomplishment considering that most small businesses fail in less than three years. Living at home with her mother, Jade saved enough money to open her nail salon fresh out of nail school at age 25.

Despite a rocky start, Jade was able to build up her business and after a couple of years was able to enjoy a good living from her nail salon. In fact things were going so well that when a space almost twice the size of her current location opened just two doors down, she decided to move to the bigger space and expand into the tanning business by installing six tanning beds in the new space. Jade was feeling good, everything was going great. She bought her first house and moved into it. Jade finally attained the American dream. Then two weeks later she got the letter from the IRS.

The Longest Year

The letter from the Internal Revenue Service was innocuous enough – mixed in with the salon’s mail, it looked just like any other piece of business correspondence.

When Jade realized that it was indeed from the IRS, she felt a twinge of concern, but not panic. As a business, Jade would periodically get notifications and letters from the IRS or the State but this letter was different. Jade opened the letter and read the words, “Your Federal tax returns for the selected tax years have been assigned to me for examination.” The vague sense of unease Jade originally felt was now panic in full bloom.

Jade immediately got on the telephone with her accountant and told him of the letter she received. She even faxed him a copy so he could see it for himself. Sure enough Jade’s last three years of business income tax returns were selected for examination.

Her accountant said don’t worry as he felt confident that this was just a random audit and that Jade’s recordkeeping and reporting to the IRS was done by the book. So the accountant told Jade to contact the IRS agent and arrange for him to come to the business and meet her and look at the business’ books and records.

And so Jade contacted the IRS agent and scheduled a meeting at the salon.

The IRS agent came to the salon and he was business-like, but very pleasant – the agent seemed like someone you could talk to. Apparently the IRS agent very much wanted Jade to think this audit wasn’t a big deal so Jade would open up to the agent.

 

The meeting lasted two and a half hours and the agent asked a lot of questions:  When did we open? How are we set up? Who set up the business organization? Do we write off our car? What kinds of benefits do we give workers? Where do we buy our boutique items?

After leaving the salon that day, the IRS agent went to the office of Jade’s accountant, where the agent spent six hours reviewing the business’ corporate records, check registers, bank deposit slips, car mileage logs, and other papers. The agent returned to the accountant’s office for three additional days.

The examination of Jade’s records was exhaustive and comprehensive but the accountant was confident that the agent would be able to agree with just about everything as reported on the tax returns. The accountant even told this to Jade and further added that he would be very surprised if the proposed liability was more than $1,000.

“You’re joking … Right?”

And a few weeks thereafter, the IRS agent issued a letter. What the agent concluded in that letter about Jade’s business was a shocker. Jade had been classifying her workers as independent contractors. The IRS agent felt they should be classified as employees and under this classification Jade would now owe the IRS $85,000.

Jade was confident that her setup was legal and legitimate because before she even opened the nail salon’s doors, she had consulted and paid a CPA to help her write the business plan and set up the business, including how to classify her workers. The CPA set Jade’s nail technicians as independent contractors. The CPA said he represented a lot of beauty salons, and he said that’s how all the salons were classifying their workers.

But the IRS agent did not agree.

In a nutshell, the IRS agent based his determination on five factors:

1. Realization of Profit or Loss…There was no element of risk for the nail technicians because they did not bear any of the financial burdens of the nail salon, such as rent, utilities, and insurance.

2. Significant Investment … None of the nail technicians had any significant financial investment in the shop. All the investment was by Jade.

3. Integration … The services of the nail technicians were fully integrated into the business operations – meaning that without the services of the nail technicians, Jade could not have continued business operations as a successful nail salon.

4. Payment by Hour, Week, and Month … Upon completion of each customer serviced, the nail technicians then turned over the total received to the Jade. The nail technicians could not retain these payments from customers.

5. Set Hours of Work … The business did not require the nail technicians to work set hours, but Jade allocated the hours the nail technicians would be available.

Well this was not acceptable to Jade so she hired a tax attorney to appeal this determination and fight the IRS.

Despite the IRS agent’s assertion that the workers should be treated as employees, Jade had some good facts favorable to her entitling her to treat the workers as independent contractors.

For one thing, a few years earlier she received a form letter from the State requesting that she complete a questionnaire about her workers and return it to the State. She completed the questionnaire and soon after received a letter from the State confirming that her workers were independent contractors.

In the questionnaire Jade noted that the nail technicians set their own hours. They didn’t get any benefits from the business. Everyone paid their own taxes and they knew they were responsible to pay for their own taxes.

Despite building a case to support classification of the workers as independent contractors, the position of the Appeals Officer at the IRS Office Of Appeals was that Jade still maintained enough control over the workers that they should be treated as employees.

Now this determination could be appealed to the U.S. Tax Court but to fight the IRS in court meant as much as $25,000 in legal fees, plus the $85,000 for the three years if Jade lost. But there was another option for Jade.

If Jade were to agree to convert her workers to employees and now start taking out taxes, provide worker’s compensation and liability insurances, and pay the employer’s share of their future earnings in Social Security taxes, and supply them completely, the IRS would substantially lower the liability for the prior years. In Jade’s case the liability would now drop below $20,000

Jade said at this point I have got to go with this option. So she made the changeover and paid the $20,000 to IRS. Turns out only two nail technicians left due to the changeover in worker status.

Older and Wiser

Things are looking good again to Jade who says the nail business is stronger than it’s ever been. She has increased her business, which has increased her income. She also recently upgraded her tanning salon with all new stand-up beds. Just like when she first opened, it’s the tanning beds that are pulling the salon through in the slow times.

She also has eliminated some things, like entertainment expenses and she started buying product in bulk to cut down costs. After the switch in worker status to employees, Jade raised service prices by about 5% to help cover the now higher costs of doing business. To her surprise, it didn’t hurt business at all. It was Jade’s first price increase in nine years anyway, so it was time. Jade does not know of one client who left as a result of these changes.

Jade’s story serves as a good lesson to anyone operating a business or looking to start a business which is that you need to know the rules and follow them. Don’t think that you are immune from the IRS questioning your business.

Starting in 2015, businesses with at least 50 full-time employees must offer affordable health insurance to all employees or substantial penalties will be imposed. If independent contractors are converted to employee status, this may result in a company having more than 50 full-time employees. Also, the IRS is starting a project to conduct 6,000 random audits over a period of three years with worker classification/misclassification as a key focus. The IRS anticipates that when the project is completed, it will pursue employment tax referrals from state agencies that deal with the classification of workers for both workman’s compensation and unemployment purposes.

Don’t take the chance and lose everything you have worked for. Be a survivor and be successful – which is why you listen to our show.

When we come back we are going to tell you how you can get out of IRS trouble if you have workers you are treating as independent contractors.

You are listening to Jeffrey Kahn the principal tax attorney of the kahntaxlaw team on the KahnTaxLaw Radio Show on ESPN.

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Welcome back. This is KahnTaxLaw Radio Show on ESPN and you are listening to Jeffrey Kahn the principal tax attorney of the kahntaxlaw team.

Calling into the studio from our San Francisco Office is my associate attorney, Amy Spivey.

Chit chat with Amy

Would Your Business Survive an Audit?

Jeff says, Like Jade and her nail salon, I do not know of any business owner who wants to be audited by the IRS or their state tax authority.  Audits can be simply random as “decided” by the IRS computer, or they can be triggered by certain characteristics of your business operation, for example how you’ve classified independent contractors or employees (especially if they apply for unemployment insurance, worker’s compensation benefits, or even welfare).

 

Amy, you have identified three key items the IRS and state tax authorities look for if you are an independent contractor or if you use them in your business

In the context of Jade’s nail salon, Jeff to read off each and Amy to explain.

1. Is there a lease between the independent contractor and the owner?

There must be a lease signed by the salon owner/landlord and each booth renter for every year of the audit. The IRS and your state can audit your records for the past three years (or as far back as they want if they determine your returns were fraudulent). The lease must clearly define the day-to-day operations of the booth rental operation and clearly define the separation between the salon owner/landlord and the booth renter. It should be clear how and when rent is paid: how service receipts are collected: hours of operation (hint: the independent contractor sets her own); receptionist services; who provides the equipment; who pays for supplies. Every aspect of the relationship must be spelled out.  A true independent contractor can incur financial loss (which means she invests in the business as well as earns a living from it).The salon owner must not have any control over when, where, or how the independent contractor works.

2. How is rent paid?

This was an area that got Jade in trouble. Independent contractors must pay a flat rate – not a percentage of their service income – based on the space used. Tax agencies take a dim view on charging rent as a percentage of services because it makes it difficult for the independent contractor to incur a loss (0% of 0 income is not a loss). Paying a commission also ties the economic well-being of the salon owner to the independent contractor, making it harder to argue that the independent contractor’s services are not integral to the success of the salon.

3. Who collects payment for services rendered?

Again, this area got Jade in trouble. The booth renter is responsible for collecting payment for all services rendered.  That doesn’t just mean taking the money from them at the front desk; it means the independent contractor must have her own cash box and have checks in her name.  They should be able to make change for cash paying customers and handle bad checks. A good rule of thumb is that a salon owner should never give an independent contractor money, and she should never issue an independent contractor a 1099 form.

Jeff says, now we only discuss three factors but the IRS and State tax agencies have other factors they can consider in determining whether the relationship is truly that of salon owner/landlord and independent contractor.

PLUG: And that is where our expertise and guidance can make a difference. The Law Offices Of Jeffrey B. Kahn will provide you with a Tax Resolution Plan which is a $500.00 value for free as long as you mention the KahnTaxLaw Radio Show when you call to make an appointment. Call our office to make an appointment to meet with me, Jeffrey Kahn, right here in downtown San Diego or at one of my other offices close to you. The number to call is 866.494.6829. That is 866.494.6829.

 

Jeff asks, so where a business has been treating its workers as independent contractors and there is a concern that the IRS in an audit would not respect this arrangement, what can the business do?

Amy replies: The business should consider entering into the IRS’ Voluntary Classification Settlement Program (VCSP). The VCSP is a voluntary program that provides an opportunity for taxpayers to reclassify their workers as employees for employment tax purposes for future tax periods with partial relief from federal employment taxes. To participate in this voluntary program, the taxpayer must meet certain eligibility requirements and apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.

 

Jeff asks, what is the eligibility for this program?

 

Amy replies, The VCSP is available for taxpayers who want to voluntarily change the prospective classification of their workers. The program applies to taxpayers who are currently treating their workers (or a class or group of workers) as independent contractors or other nonemployees and want to prospectively treat the workers as employees.

 

A taxpayer must have consistently treated the workers to be reclassified as independent contractors or other nonemployees, including having filed all required Forms 1099 for the workers to be reclassified under the VCSP for the previous three years to participate.

 

Additionally, the taxpayer cannot currently be under employment tax audit by the IRS [income tax audit is OK] and the taxpayer cannot be currently under audit concerning the classification of the workers by the Department of Labor or by a state government agency.

 

If the IRS or the Department of Labor has previously audited a taxpayer concerning the classification of the workers, the taxpayer will be eligible only if the taxpayer has complied with the results of that audit and is not currently contesting the classification in court.

 

Jeff asks, so for a business that qualifies for VCSP what are they looking at for penalties?

 

Amy replies, A taxpayer participating in the VCSP will agree to prospectively treat the class or classes of workers as employees for future tax periods. In exchange, the taxpayer will:

• Pay 10% of the employment tax liability that would have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates of section 3509(a) of the Internal Revenue Code;
• Not be liable for any interest and penalties on the amount; and
• Not be subject to an employment tax audit with respect to the worker classification of the workers being reclassified under the VCSP for prior years.

 

PLUG: The VCSP is a valuable program that a business owner should consider. The Law Offices Of Jeffrey B. Kahn will provide you with a Tax Resolution Plan which is a $500.00 value for free as long as you mention the KahnTaxLaw Radio Show when you call to make an appointment. Call our office to make an appointment to meet with me, Jeffrey Kahn, right here in downtown San Diego or at one of my other offices close to you. The number to call is 866.494.6829. That is 866.494.6829.

 

Now if your business treats all of its workers as employees, don’t think that you can still avoid IRS trouble. Stay tuned and you will find out why.

 

You are listening to Jeffrey Kahn the principal tax attorney of the kahntaxlaw team on the KahnTaxLaw Radio Show on ESPN.

 

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Welcome back. This is KahnTaxLaw Radio Show on ESPN and you are listening to Jeffrey Kahn the principal tax attorney of the kahntaxlaw team.

 

And on the phone from our San Francisco office I have my associate attorney, Amy Spivey.

 

When Payroll Taxes Pyramid It Means Penalties, Even Jail

 

Jeff asks, does the IRS pursue all taxes equally?

 

Amy replies, not really. The IRS is especially vigorous in going after payroll taxes withheld from wages that somehow don’t get paid to the government.  The IRS calls it trust fund money that belongs to the government.

 

That makes any failure to pay—or even late payment—much worse.

 

In fact, that’s so regardless of how the employer or its principals use the money, and regardless of how good a reason they have for not handing the money over to the IRS. When a tax shortfall occurs in this setting, the IRS will usually make personal assessments against all responsible persons who have an ownership interest in the company or signature authority over the company accounts.

 

Jeff asks, how does that work?

 

Amy replies, The IRS can assess a Trust Fund Recovery Assessment, also known as a 100-percent penalty, against every “responsible person.” The penalty is assessed under Section 6672(a) of the tax code, and the IRS uses it liberally. You can be responsible and therefore liable even if have no knowledge that the IRS is not being paid. If there are multiple owners, multiple officers, multiple check signers, they all may draw a 100% penalty assessment.

 

Jeff asks, what happens when multiple owners and signatories all face tax bills?

 

Amy replies, they generally squabble and do their best to sic the IRS on someone else. Factual nuances matter in this kind of mud-wrestling, but so do legal maneuvering and just plain savvy. One responsible person may get stuck paying while another who is even guiltier may get off scot-free.

Jeff asks, so if the IRS is going after individuals, does the IRS stop any collection action against the company?

 

Amy says, No, the government will still try to collect from the company that withheld on the wages. The IRS also wants to make sure this kind of bad tax situation doesn’t occur again.

 

Jeff says, now so far you have talked about civil exposure which involves solely the payment of money. Can the government see criminal penalties?

 

Amy says, sure they can and the government will typically seeks to enjoin this behavior. That was the approach the government took with Advanced Underground Construction, an Iowa-based company, and its principal, William David Ward II. The Justice Department sought an injunction against both, alleging the company repeatedly failed to pay federal employment taxes withheld from wage checks, the amount now due exceeding $370,000.

 

The company was using the withheld taxes as working capital, the suit claimed. The government usually succeeds with this kind of argument. In this case, the Federal Court Ordered the Iowa Construction Company to Pay Employment Taxes.

 

The practice the government was going after is sometimes called “pyramiding.” The DOJ noted that the company had made minimal payments of its tax debts, and that attempts to induce voluntary compliance failed. To stop the bleeding in a case like this, the Justice Department can seek an injunction to require a company and its principals to make timely tax deposits, to pay all withheld employment taxes, and to timely file all employment tax returns.

 

Jeff says, and what happens to the principals if they fail to comply with the injunction?

 

Amy replies, they will be held in contempt and put into jail.

 

PLUG: The Law Offices Of Jeffrey B. Kahn will provide you with a Tax Resolution Plan which is a $500.00 value for free as long as you mention the KahnTaxLaw Radio Show when you call to make an appointment. Call our office to make an appointment to meet with me, Jeffrey Kahn, right here in downtown San Diego or at one of my other offices close to you. The number to call is 866.494.6829. That is 866.494.6829.

5 Payroll Tax Mistakes to Avoid

 

Jeff says: If you have at least one employee, you are responsible for payroll taxes. These include withholding federal (and, where appropriate, state) income taxes and FICA tax from employees’ wages as well as paying the employer share of FICA tax and federal and state unemployment taxes. The responsibility is great and the penalties for missteps make it essential that you do things right.

 

Jeff to read off each tip and Amy will reply.

 

1.  Misclassifying workers

Perhaps the hottest audit issue today is misclassifying workers. There’s incentive to treat workers as independent contractors rather than employees because payroll taxes and employee benefit costs are high; a company’s only tax responsibility for an independent is issuing a Form 1099-MISC if payments in the year are $600 or more.

You don’t have the freedom to select the label for the worker; classification depends on whether you have sufficient control over the worker. This essentially means having the right to say when, where, and how the work gets done. Having an independent contractor agreement is helpful in showing that you and the worker do not intend any employer-employee relationships, but it doesn’t bind the IRS, who is not a party to the agreement.

 

2.  Not using an accountable plan for employee reimbursements

If you normally pay for travel, entertainment, tools or other business costs for employees, you’re wasting employment tax dollars if you don’t use an accountable plan. With this arrangement, you deduct the expenses but avoid all payroll taxes on reimbursements; employees do not have any income from reimbursements.

To be an accountable plan, the employer must formalize the arrangement and set reasonable times for action (the following times are reasonable to the IRS but you can adopt shorter time limits for action):

• The reimbursable expense must be business related.
• Advances cannot be made before 30 days of the expense.
• Employees must account for the expenses within 60 days of the expense.
• Employees must return excess reimbursements to the employer within 120 days of the expense.

 

3.  Failing to keep payroll records

You are required to maintain payroll records and have them available for IRS inspection. These include time sheets, expense accounts, copies of W-2s and other payroll records. Usually, you should keep information for at least four years.

 

You should also retain copies of Forms I-9, which shows an employee’s eligibility to work in the U.S. States may also have certain hiring forms that should be retained (e.g., E-verify forms).

4.  Choosing to pay creditors before the IRS

When a business gets into a cash crush, it may be tempting to pay the landlord, vendor, or utility company before the IRS; don’t! As a business owner, you are a “responsible person” who remains 100% personally liable for “trust fund” taxes (amounts withheld from employees’ wages). This is so even if your business is incorporated or is a limited liability company.

 

Best strategy: Set aside cash to cover payroll taxes so you won’t use these funds for any other purpose.

 

5.  Failing to monitor payroll company activities

Many small businesses use outside payroll companies to handle the job of figuring withholding as well as transferring funds to the U.S. Treasury to cover payroll taxes. However, some of these companies may not do their job, by error or intentionally. As an employer, even if you use an outside payroll company you remain responsible for payroll taxes.

 

Best protection: Monitor your tax account to see that funds are being deposited on time and in the correct amount. If deposits are made electronically using EFTPS.gov, you can easily see activities in your account.

 

PLUG: The Law Offices Of Jeffrey B. Kahn will provide you with a Tax Resolution Plan which is a $500.00 value for free as long as you mention the KahnTaxLaw Radio Show when you call to make an appointment. Call our office to make an appointment to meet with me, Jeffrey Kahn, right here in downtown San Diego or at one of my other offices close to you. The number to call is 866.494.6829. That is 866.494.6829.

 

Stay tuned as we will be taking some of your questions. You are listening to Jeffrey Kahn the principal tax attorney of the kahntaxlaw team on the KahnTaxLaw Radio Show on ESPN.

 

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Welcome back. This is KahnTaxLaw Radio Show on ESPN and you are listening to Jeffrey Kahn the principal tax attorney of the kahntaxlaw team along with my associate attorney, Amy Spivey.

 

If you would like to post a question for us to answer, you can go to our website at www.kahntaxlaw.com and click on “Radio Show”. You can then enter your question and maybe it will be selected for our show.

 

OK Amy, what questions have you pulled from the kahntaxlaw inbox for me to answer?

 

1. What is the new maximum wage amount in 2015 that would be subject to a total Social Security FICA tax of 12.4%?

 

That amount will be $118,500. (Up from $117,000 in 2014). Remember that the employer pays 6.2% and the other 6.2% is withheld from the employee’s paycheck.

 

2. What is the regular Medicare Tax that applies to compensation?

 

There is no limit on the amount of earnings subject to Medicare (Hospital Insurance) Tax. The Medicare Tax Rate applies to all taxable wages and remains a total of 2.9% (with 1.45% withheld from the employee’s paycheck).

 

3. What is the new additional Medicare Tax that came into place?

 

Additional Medicare Tax went into effect in 2013 and applies to wages, compensation, and self-employment income above a threshold amount received in taxable years beginning after Dec. 31, 2012. The rate is 0.9%.

 

An individual is liable for Additional Medicare Tax if the individual’s wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) exceed the threshold amount for the individual’s filing status:

Filing Status	Threshold Amount
Married filing jointly	$250,000
Married filing separate	$125,000
Single	$200,000
Head of household (with qualifying person)	$200,000
Qualifying widow(er) with dependent child	$200,000

 

4. When does the new additional Medicare Tax get reported and paid?

 

You will report Additional Medicare Tax on Form 8959, Additional Medicare Tax, and attach Form 8959 to your income tax return.

 

5. What payroll tax liabilities of my business could I be personally liable for?

 

It would be for those liabilities we call “Trust Fund Liability”. This constitutes those amounts an employer is required to withhold federal income and payroll taxes from its employees’ wages and pay them to the IRS. Withheld payroll taxes are called trust fund taxes because the employer holds the employees’ money (federal income taxes and the employee portion of Federal Insurance Contributions Act (FICA) taxes) in trust until a federal tax deposit of that amount is made.

 

If you have any responsibility for a business you will want to make sure you do not have this personal exposure.

 

PLUG: The Law Offices Of Jeffrey B. Kahn will provide you with a Tax Resolution Plan which is a $500.00 value for free as long as you mention the KahnTaxLaw Radio Show when you call to make an appointment. Call our office to make an appointment to meet with me, Jeffrey Kahn, right here in downtown San Diego or at one of my other offices close to you. The number to call is 866.494.6829. That is 866.494.6829.

 

Thanks Amy for calling into the show. Amy says Thanks for having me.

 

Well we are reaching the end of our show.

 

You can reach out to me on Twitter at kahntaxlaw. You can also send us your questions by visiting the kahntaxlaw website at www.kahntaxlaw.com. That’s k-a-h-n tax law.com.

 

Have a great day everyone!