Tax & Business Insights

New IRS Checks on Employment Tax Practices

Volume 20 Issue 3 --  May/June 2008

IRS MOU and QETPs?  No, the IRS did not buy a cow with a moo (speech) impediment.  MOUs are Memorandums of Understanding usually between the IRS and a state.  A new MOU is designed to spotlight Questionable Employment Tax Practices (“QETPs”).  What are QETPs and why is the IRS interested in stopping them? 

An example of a QETP abuse:  Asa says to Ziba (both owners of A-Z Drywall Inc.), “Let’s convert all of our employees to independent contractors, reduce payroll taxes, eliminate the filing of 941 and 940 federal returns, and comparable state returns.”  As farfetched as this approach sounds, it is sometimes done, particularly when businesses find that they are strapped for income, as in the current economy.

Prior to the QETP MOU, there were approximately 29 states that had tax pacts to exchange information with the IRS.  You may question, why do we need a new acronym to add to the welter of acronyms in tax practice already?

Recently Congress finally realized it takes real money to wage wars in distant places.  Now there is an emphasis in Congress to crack down on questionable employee tax practices and raise tax compliance from 86% to 90%.  Before QETP, the IRS would audit some businesses for employment or payroll practices to see if workers were properly classified, etc. 

In the A-Z Drywall example, if the IRS started a payroll audit of A-Z it would reclassify the workers from alleged independent contractors to employees.  A-Z would then be subject to a special set of tax provisions and the business would have to pay the IRS a deficiency for attempting to reduce its payroll expense by incorrectly classifying employees as independent contractors.  

Tax practitioners are aware that many types of workers, regardless of classification, do not file tax returns.  From a Treasury perspective, treating workers as independent contractors magnifies the tax receipts problem because independent contractors are thought to be the group most likely to fail to file. 

 Some have begun to call the failure of businesses to remit 941 taxes as “pyramiding” (or building up a huge withholding tax debt).  The essence of the “failure to remit 941 taxes” problem  in many cases, seems not to be a desire to fraudulently build  941 tax debts but a foolish propensity to take unreasonable chances. 

In many cases employers believe that the “next big job” is just around the corner if the business can be kept afloat for a few more weeks or months.  What these employers are doing is choosing to use the IRS as a banker.  Borrowing from the IRS is a recipe for financial disaster.  Failing to pay 941 taxes is one of the reasons that there is a special provision that imposes a Trust Fund Recovery Penalty on those business owners or responsible parties who fail to remit the withholding taxes.

Rather than adopt a new official acronym, QETP, it would be far better for the IRS to improve its computer system so that IRS Revenue Officers would be knocking on the door of an employer that is only as many as 2 quarters behind on withholding taxes. 

As it is now, the IRS often allows many employers to go 6, 7 or 8 quarters without paying employment taxes before an IRS Revenue Officer arrives.  The IRS says that they do not come in more quickly because of the lack of resources and employees.  A new acronym will not solve the IRS lack of staffing.

Other QETP alleged abuses are unreliable third-party payors (in other words payroll services) that cheat, off-shore leasing of employees, S corporations treating loans as a substitute for salary and similar practices.

The QETP emphasis, if it is followed by adequate IRS staffing, may lead to additional emphasis on audits of payroll practices.  Anecdotal evidence indicates that before the recent QETP emphasis, traditional payroll audits had all but disappeared because they are difficult to do and require experienced senior IRS auditors. 

Until a different or better tax system is enacted we will have to continue muddling along with the IRS.  Despite the desire to stop questionable employee tax practices, it is not likely that the IRS will have the resources in the near term to effectively stop alleged QETP abuses.  Working with state tax agencies in a combined effort raises additional questions. Most state tax authorities lack agents with the training and experience to deal with payroll audits. 

If you or your clients have further needs in this area, you may want to call The Tax and Business Professionals.

Copyright 2008
By Tax and Business Professionals, Inc.
9837 Business Way
Manassas, VA 20110
(800) 553-6613

While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.

Redistribution or other commercial use of the material contained in Tax & Business Insights is expressly prohibited without the written permission of Tax and Business Professionals, Inc.