Newland's Business Notes

Is the IRS Targeting Latino Businesses: Part 2?

Volume 12 Issue 6 -- November/December 2008

In the last issue of this newsletter ("Is the IRS Targeting Latino Businesses?") we discussed Haz Panico and his sole proprietorship Haz Drywall which received very questionable IRS audit treatment. 

In addition to the dubious audits which may be targeting small Latino businesses, there are other weapons in the arsenal of the IRS. In an earlier newsletter (“Backup Withholding (Hernando’s Horrors)” we considered the IRS use of No-Match Letters (CP-2100) and backup withholding.

Another tool in the IRS arsenal is the employment tax audit. Employment tax audits consist of the IRS auditing a business to see if the workers are employees or independent contractors (IKs).

In the case of employees, employers are required to withhold tax on the employee’s wages as well as to collect and pay additional employment tax amounts for Social Security and unemployment compensation. In the case of IKs, however, there is no withholding and the IK is responsible for making quarterly estimated tax payments as well as paying Self-Employment Tax for Social Security.

The IRS has published a 20 question list that it uses to determine whether a worker is an employee or IK. 

No one question or response is determinative and in close situations the employee status is hard to determine.  For example, some workers move frequently from one drywall company to another, as well as moving from state to state.  Are such workers independent?  Usually, there are no fringe benefits or no traditional employee benefits.

In the situation where a worker, say Jose, works only for Haz Drywall, the status issue may be easier to resolve.  The status of Jose as an employee is more clearly defined if Jose is required to wear a uniform, reports to work at the same time each day, etc.

The problem the IRS seems to have with employment tax audits is the manpower (or womanpower) needed to complete such audits. Employment tax audits are very labor intensive and require the IRS auditor to look at each employee/worker for each quarter.  Then the IRS must compute the applicable additional withholding (941) tax for the company after examining the status of each worker, because Jose may have been a bona fide IK from January to June and then become an employee for the rest of the year.

One of the issues which bothers small businesses, both Hispanic and otherwise, is losing workers as a result of a conversion from independent contractor to employee status. The business’s ability to continue may be greatly impaired.

In some situations, Jose may suspect that Haz is collecting the employee withholding and not remitting the funds to the IRS as Haz should be doing.  If Jose has been receiving gross amounts of compensation for years and there is a sudden reduction in his take-home amount, Jose may simply leave and seek work elsewhere.

It should be remembered that many tradesmen speak English as a second language.  Trying to explain the status of workers and complex tax rules is daunting in English and, naturally, more difficult in a second language.  What should/could Haz do?

In the past when some businesses were unable to obtain workers unless the workers were paid cash on the spot, no CP2100 notices of possible payee name/TIN discrepancies were issued or employment tax audits initiated.  The IRS effectively acquiesced in situations where the only way workers could be obtained to pick up the trash were if the workers were paid cash each day without any withholding. Whether Latino business owners can succeed in making the same argument today is questionable.

The ultimate effect may be that Hispanic workers will be forced to become part of the taxpaying system. The Washington Post has run articles about how some initially illegal Latino immigrants were eager to begin paying tax so that they could become part of the taxpaying system for purposes of obtaining a green card and eventually U.S. citizenship. The possibility of any significant relief for businesses such as Haz Drywall is not likely. The best result will be that all of the workers will obtain valid ITINs or SSNs. Will this happen? Probably not.

If you have questions about the status of your workers, call Newland & Associates, PLC, for advice.

Copyright 2008

Published by the law firm of Newland & Associates, PLC
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Call us at (703) 330-0000 for a full range of business law and tax-related services.

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