The Employment Tax Audit The Employment Tax Audit Part 2 of 3 Part Series Part 2 of 3 Part Series Chaya Kundra, Moderator, Chaya Kundra, Moderator, Kundra & Associates Kundra & Associates Anthony G. Arcidiacono, Anthony G. Arcidiacono, Ernst & Young LLP Ernst & Young LLP Anita Bartels, Anita Bartels, Employment Tax Policy Employment Tax Policy Vincent S. Canciello, Vincent S. Canciello, Ernst & Young LLP Ernst & Young LLP Thomas M. Cryan, Thomas M. Cryan, Miller & Chevalier* Miller & Chevalier* *Marianna G. Dyson, Miller & Chevalier *Marianna G. Dyson, Miller & Chevalier American Bar Association Employment Tax Section JANUARY 21, 2011
Transcript
The Employment Tax AuditThe Employment Tax AuditPart 2 of 3 Part SeriesPart 2 of 3 Part Series
� The employment tax liability is substantially correct
� Information returns and wage statements have been filed properly
IssuesIssues
� Worker classification
� The IRS “Never met an employee it did not like”
� Evaluate the primary categories of evidence
� A worker is an employee when the person for whom the services are performed has the right to control and direct the individual who performs the services as to what is to be done & how it is to be done
Worker ClassificationWorker Classification
Determine the extent of behavioral control
� 1) Instructions
� 2) Training
Determine extent of Financial ControlDetermine extent of Financial Control
1) Significant investment
2) Unreimbursed expenses
3) Services available to the relevant public
4) Opportunity for profit or loss
5) Method of payment
Determine the Extent of the Determine the Extent of the
Relationship of the PartiesRelationship of the Parties
1) Employee benefits
2) Intent of the parties
3) Permanency
4) Discharge/termination
5) Regular business activity
Working Condition Fringe Working Condition Fringe
Benefit Exclusion under Benefit Exclusion under
Code Code §§ 132(d)132(d)
Working Condition Fringe Benefit Working Condition Fringe Benefit
� IRC § 61(a) provides that, except as otherwise provided “…gross income means all income from whatever source derived, including (but not limited to) . . . [c]ompensation for services, including . . . fringe benefits . . . ”
� There is a presumption that the value of a fringe benefit provided to an employee must be treated as additional wages (subject to payroll taxation), unless it is specifically excluded from gross income by another section of the IRC. Treas. Reg. § 1.61-21(a)(2)
Working Condition Fringe Benefit Working Condition Fringe Benefit
The WCF exclusion generally covers any property or services provided to an individual performing services for the employer: (IRC § 132(d), Treas. Reg. § 1.132-5)
� To the extent the costs would have been deductible by the recipient under § 162 or 167 (including § 274 substantiation requirements, as required), if the recipient had paid for them
� If the costs relate to the employer’s business
� If the recipient is a current employee (“EE”) for purposes of the exclusion (i.e., is not a retired person or a spouse or child of a current worker)
� Whether or not the benefits are provided on a discriminatory basis
� Provided the worker has no choice between cash and the benefit
Working Condition Fringe Benefit Working Condition Fringe Benefit
Exclusion: Definition of Exclusion: Definition of ““EmployeeEmployee””� Treas. Reg. § 1.132-1(b)(2) defines an “employee” for
WCF purposes as –◦ any individual who is currently employed by the employer◦ any partner who performs services for the partnership◦ any director of the employer◦ any independent contractor who performs services for the employer
� Limitation with respect to independent contractors and directors◦ An independent contractor cannot exclude the value of parking or the use of consumer goods pursuant to a product testing program; and◦ an outside director cannot exclude the value of the use of consumer goods pursuant to a product testing program.
Working Condition Fringe Benefit Exclusion: Working Condition Fringe Benefit Exclusion:
� The requirement that the EE must have been able to deduct the cost means that all EEs must keep records under § 274(d) for all “listed property,” all travel expenses, any entertainment activities, and all gifts.
� If no records are kept of the business purpose, and there is no regulatory safe-harbor exclusion from the recordkeeping requirement, the WCF provision will not apply to exclude the value of the benefit from the EE’s income (and wages). Treas. Reg. § 1.132-5(c)(1).
� If deduction is available to EE under § 162 the WCF exclusion applies without regard to the 2% floor.
Examples of Benefits That Examples of Benefits That MayMay be Considered be Considered
a Working Condition Fringe Benefita Working Condition Fringe Benefit
� Cell phones and laptops
� Travel expenses and per diem payments
� Flights on company aircraft
� Spousal travel
� Company-provided cars
� Executive physicals
� Home office
� Security protection for executives
� Country club or airline club dues
� Outplacement services
� Use of office supplies and equipment
Four Hot Working Condition Four Hot Working Condition
� Travel expense and per diem issues (Treas. Reg. §§ 1.132-5(a)(1)(v) and 1.62-2(c))
� Personal use of the corporate aircraft, including flights provided to spouses
� Employer-provided cell phones and cell phone service
� Employer-provided cars
Working Condition Fringe Benefit Travel Expense Working Condition Fringe Benefit Travel Expense
Reimbursement Rule of Treas. Reg. Reimbursement Rule of Treas. Reg. §§ 1.1321.132--5(a)(1)(v)5(a)(1)(v)
� A cash payment to an EE does not qualify as a WCF unless the EE is required to:
◦ use the payment to pay for a specific or pre-arranged activity deductible under §§ 162 or 167;
◦ verify that the payment is used for the expense; and
◦ return to the employer any unused portion of the payment.
� These rules resemble the more detailed accountable plan rules of § 62(c) and Treas. Reg. § 1.62-2.
� But, remember, an independent contractor can be an “employee” for WCF purposes.
Travel Expenses and Per Diem Arrangements: Travel Expenses and Per Diem Arrangements:
Intersection of Intersection of §§ 62(c) Rules62(c) Rules
� Requirements for maintaining a Travel/Expense plan that meets the accountable plan requirements of §62(c) and Treas. Reg. § 1.62-2:
◦ Business connection under § 162
◦ Timely substantiation
◦ Allowances reasonably calculated to cover expenses
◦ Specific identification of reimbursement or allowance
◦ Timely return of “spare change” from advances
� Prohibition against “abusive arrangement” (§ 1.62-2(k))
Recurring Issues for Travel Recurring Issues for Travel
Expense and Per Diem Expense and Per Diem
ArrangementsArrangements� Application of the one-year rule under § 162(a)
and its affect on the employee’s “tax home”
◦ A “tax home” is the location of the employee’s principal place of business (i.e., the location where the employee works the most and has the most business contacts (e.g., direct reports, supervisor, etc.)).
� The problem of the bi-coastal executive – which location is the executive’s tax home?
� The problem of the peripatetic employee – does the continuously traveling employee even have a tax home?
Use of the Corporate Plane and Spousal Travel: Use of the Corporate Plane and Spousal Travel:
Deduction Limitation on Spousal TravelDeduction Limitation on Spousal Travel
Section 274(m)(3) disallows deductions (otherthan moving expenses) for spouse’s/guest’s travelexpenses when traveling with the employee onbusiness travel, unless spouse:
� Is a bona fide employee of employer
� Is also traveling for a bona fide business purpose, and
� Would otherwise be able to deduct the expenses under § 162(a)
Use of the Corporate Plane and Spousal Travel: Use of the Corporate Plane and Spousal Travel:
ERER’’s Election in the Case of Business Travels Election in the Case of Business Travel
� Treas. Reg. § 1.132-5(t) concedes that employers have a choice between taxing the employee and absorbing the deduction disallowance for expenses related to any bona fide business travel by a spouse
� Alternatively, the employer may elect to treat the value of the spouse’s business travel benefits as additional wages, deduct payroll taxes and report the wages on Form W-2, and then deduct the travel expenses
� The value of spousal travel benefits that do not qualify as bona fide business travel must be treated as wages
Use of the Corporate Plane and Spousal Use of the Corporate Plane and Spousal
Travel: Special Valuation Rule for Personal Travel: Special Valuation Rule for Personal
UseUse� Personal use (including entertainment use) by executive (“control employee”) and guests may be valued under special valuation rule known as the SIFL formula (Treas. Reg. § 1.61-21(g))
◦ In using SIFL formula, the value of each flight is determined on a passenger-by-passenger basis
◦ Deadheads not counted; roundtrips treated as 2 flights
◦ Additional favorable valuation may apply when at least 50% of regular passenger seating capacity of aircraft is filled by business travelers
◦ If SIFL is elected, consistency requirement must be met
Use of the Corporate Plane and Spousal Travel: Use of the Corporate Plane and Spousal Travel:
Valuation of Mixed Business/Personal FlightsValuation of Mixed Business/Personal Flights
� Combination, in one trip, of personal and business flights
� If flight is primarily for employer’s business, employer must include in wages the excess of SIFL value of the flights comprising the trip over the SIFL value of the flights that would have been taken if there had been no personal flights
� If trip is primarily personal, the amount includible in wages is the value of the personal flights that would have been taken had there been no business flights, but only personal flights
Use of the Corporate Plane and Spousal Use of the Corporate Plane and Spousal
� General rule: employer may deduct costs attributable to provision of fringe benefit (Treas. Reg. §§ 1.162-25 and 1.162-25T)
� AJCA of 2004 amended § 274(e)(2) to limit deductions for entertainment expenses incurred by “specified individuals”, including use of corporate aircraft, to the extent expenses are treated as compensation to an employee on the taxpayer’s return and as wages subjected to payroll taxes
� Notice 2005-45 and Prop. Treas. Reg. § 1.274-10 set forth an allocation method based on each passenger’s reason for flying rather than primary purpose test
Use of the Corporate Plane and Use of the Corporate Plane and
� Although passenger’s reason for flying is determinative for both sets of rules, “entertainment”is a subset of “personal” for deduction disallowance purposes
� Limited relaxation of requirement to use SIFL rules consistently
◦ Technically, employer can only use SIFL value or charter value as basis for imputing income, even if allocable costs fall in between
◦ If employer elects to use charter value for specified individual’s entertainment flights, charter value must be used for all such flights by all specified individuals
Use of the Corporate Plane and Use of the Corporate Plane and
� The value of deadhead flights associated with entertainment flights must be included in the deduction disallowance calculation
� Use of SIFL valuation, 50% rule, or special valuation of personal flights covered by an overall security program to impute value of personal flights forces a bigger disallowance than allocable costs
� “Specified individual” definition is broader than “control employee” and doesn’t exclude children under 2 years
� Section 280F(d)(4) characterizes cellular phones and other similar telecommunications equipment as “listed property,” imposing detailed recordkeeping requirements under §274(d) for working condition fringe benefit (§132(d)) and accountable plan (§ 62(c)) purposes
� Insufficient records of business use results in wage treatment
� With exception of sampling, no streamlined substantiation rules under § 274(d) exist in the regulations for cell phones
Small Business Jobs Act or 2010, which will likely be enacted by the end of September 2010, would remove cell phones from the definition of listed property. However, to exclude employer provided cell phones, employers will still need to satisfy the general business substantiation requirements of §162. Joint Committee explanation notes that Treasury has authority to determine whether employer-provided cell phones qualify as a WCF or a de minimis fringe benefit.
Four Hot Working Condition Fringe Benefit Four Hot Working Condition Fringe Benefit
◦ Employees are generally required to maintain detailed logs regarding the use of the vehicle, or the entire value of the vehicle must be taxed as wages
◦ Allocation of business and personal use
� Commuting is considered personal use. A commute is generally a daily trip between the employee’s principal residence and any “regular place of business.” See Rev. Rul. 99-7
� Determination of what constitutes a commute can be tricky!
EmployerEmployer--Provided Cars: Special Valuation RulesProvided Cars: Special Valuation Rules
� Special exceptions and valuation rules apply in certain circumstances:
◦ Qualified Non-personal Use Vehicles. Certain types of heavy duty trucks are exempt from recordkeeping requirements
◦ Employer Policy Permitting Commuting Only. If there are non-compensatory business reasons for the employee to have the car at home (e.g., the employee is called out in the middle of the night), a special $3.00 per day valuation and exemption from recordkeeping applies. Cannot be used for control employees (e.g., highly paid executives)
De Minimis Fringe Benefit De Minimis Fringe Benefit
Exclusion under Code Exclusion under Code §§ 132(e)132(e)
De Minimis Fringe Benefit Exclusion:De Minimis Fringe Benefit Exclusion:
Statutory FrameworkStatutory Framework
� The exclusion for “de minimis fringes” is intended to give administrative relief to employers when the benefits being provided to the employee are small in value and are infrequently provided. The definition provided by section 132(e)(1) of the Internal Revenue Code (the “Code”) for de minimis fringes is a syntactical embarrassment, even for the Internal Revenue Code
� The term “de minimis fringe” means any property or service the value of which is (after taking into account the frequency with which similar benefits are provided by the employer to the employer’s employees) so small as to make accounting for it unreasonable or administratively impracticable
De Minimis Fringe Benefit Exclusion:De Minimis Fringe Benefit Exclusion:
Statutory FrameworkStatutory Framework
� The definition essentially communicates the requirement that the value of the benefit must be small when considered within the context of two elements:
◦ (1) the frequency with which the benefit and similar benefits are provided, and
◦ (2) the level of administrative practicability and costs associated with accounting for the benefits
� This determination of value is based on all the facts and circumstances
De Minimis Exclusion: FrequencyDe Minimis Exclusion: Frequency
� Generally, it must be measured by reference to the frequency with which the benefits are provided to specific individuals (“employee-measured frequency”)
� If it would be administratively difficult to determine frequency per-employee, it may be measured by reference to the employer’s practices in providing benefits to all employees (“employer-measured frequency”), and not the frequency with which individual employees receive them, unless the benefit being provided is occasional meal money or local transportation fare. Treas. Reg. § 1.132-6(b); TAM 9148001
De Minimis Exclusion: FrequencyDe Minimis Exclusion: Frequency
� How often is too often?
� Does “tracking” the frequency defeat the argument that the benefits are de minimis?
� Big issue with –
◦ sports, theater, and entertainment-event tickets, and
◦ employee meals, group meals and parties
De Minimis Exclusion: Administrative ImpracticabilityDe Minimis Exclusion: Administrative Impracticability
� The second factor governing whether a benefit of small value must be taxed as wages is administrability
� Treas. Reg. § 1.132-6(c) provides that “[u]nless excluded by a [Code] provision ... other than section 132(a)(4), the value of any fringe benefit that would not be unreasonable or administratively impracticable to account for is includible in the employee’s gross income.”
� It is never administratively impracticable to account for cash or “cash equivalents.” See 201005014 (Oct. 28, 2009)
De Minimis Exclusion: Definition of De Minimis Exclusion: Definition of ““EmployeeEmployee””
� “Any recipient of a fringe benefit,” including family members of employees and clients/business associates. Treas. Reg. § 1.132-1(b)(3)
� Nondiscrimination rules also do not apply to this benefit (except in the limited case of employer-operated eating facilities as defined in Code § 132(e)(2))
De Minimis Exclusion: Cliff ProvisionDe Minimis Exclusion: Cliff Provision
� The availability of the exclusion operates as a cliff
� If an employer provides a benefit that exceeds either the value or the frequency limitations for de minimis fringes, the entire benefit is included in the employee’s income, not just the portion that exceeds the de minimis limit. Treas. Reg. § 1.132-6(d)(4)
Value: How much is too much?Value: How much is too much?
� No specific dollar limitation for determining whether a benefit is de minimis is stated in the statute, in IRS regulations, or other formal IRS guidance.
� Examples of various de minimis fringes given in the regulations and in the 1984 legislative history are not limited to items with particular dollar limits.
◦ Listed items such as birthday and holiday gifts, flowers, theater tickets and “group meals”typically cost more than $50
Value: Narrow Interpretation Followed by Value: Narrow Interpretation Followed by
Shrinking Valuation in IRS Informal RulingsShrinking Valuation in IRS Informal Rulings
� PLR 9442003 – the IRS concluded that the value of preparing and filing income tax returns electronically for employees (with a value of approximately $100) was a de minimis fringe benefit.
� TAM 200030001 – the value of meals provided to employees at business conferences, ranging in cost from $109 to $709 per participant were not de minimis fringe benefits.
� CCA 200108042 – the IRS concluded that “non-monetary achievement awards having a fair market value of $100 would not qualify as de minimis fringes.”
Special Issues: Gift CardsSpecial Issues: Gift Cards
� Under the principle that it is never administratively impracticable to account for cash, cash cannot be excluded from income as a de minimis fringe benefit
� Moreover, a “cash equivalent” is also not eligible for the exclusion as explained in Treas. Reg. § 1.132-6(c):
◦ Similarly, except as otherwise provided . . . , a cash equivalent fringe benefit (such as a fringe benefit provided to an employee through the use of a gift certificate or charge or credit card) is generally not excludable under section 132(a) even if the same property or service acquired (if provided in kind) would be excludable as a de minimis fringe benefit
Special Issues: Gift Cards (Continued)Special Issues: Gift Cards (Continued)
� TAM 200437030 (April 30, 2004) – the IRS ruled that a $35 employer-provided gift coupon redeemable at grocery stores for a holiday gift is not excludable from gross income and wages as a de minimis fringe benefit
◦ Specifically, the IRS concluded that gift coupons could not qualify for the exception because “cash and cash equivalent fringe benefits like gift certificates have a readily ascertainable value, [and therefore] they do not constitute de minimis fringe benefits because these items are not unreasonable or administratively impracticable to account for.”
Special Issues: Gift Cards (Continued)Special Issues: Gift Cards (Continued)
� Many taxpayers take the reasonable position that gift certificates that comply with the definition of “tangible personal property,” in Treas. Reg. § 1.274-3(b)(2)(iv) (pre-1987 regulations on employee awards) and Prop Treas. Reg. § 1.274-8(c)(2) (post-1986 regulations employee awards) should not be considered cash equivalents
� Under these rules, a nonnegotiable certificate conferring only the right to receive tangible personal property” may be treated as tangible personal property for purposes of the employee achievement award rules under Code § 274(j). Prop. Treas. Reg. § 1.274-8(c)(2)
� Softening of IRS Position?
Special Issues: Employee Lotteries/Door PrizesSpecial Issues: Employee Lotteries/Door Prizes
� Given the statutory prohibition under Code §102(c) of a gift characterization for employer-provided awards or prizes for an employee, the only practical way to exclude the value of a prize or award from an employee’s income is the de minimis exclusion
� If the value is above a “de minimis amount,” how should a door prize at a holiday party be reported?
� What about a door prize at a charity-sponsored event for your workforce?
Special Issues: De Minims Fringe Benefit Special Issues: De Minims Fringe Benefit
Exclusion and Reimbursements of CashExclusion and Reimbursements of Cash
� The IRS is particularly harsh with respect to taxpayer attempts to exclude cash reimbursements as a de minimis fringe benefit
� For example, in Rev. Proc. 2004-29 (a revenue procedure permitting statistical sampling for identifying meal and entertainment expenses subject to the 50% disallowance), the IRS stressed the ease of tracking reimbursements and concluded that payments under “accountable plans” are never de minimis fringes
� Are there workarounds for this?
Special Issues: Wellness PlansSpecial Issues: Wellness Plans
� Health plans often offer awards for plan participants engaging in certain types of preventative procedures (e.g., a physical examination) or “healthy activities”(e.g., running a 10K)
� If the health plan is employer-sponsored, absent a specific exclusion, these awards constitute taxable wages
� Even if the award qualifies as de minimis, the cafeteria plan proposed regulations prohibit offering Code section 132 fringe benefits through a cafeteria plan. See Prop. Treas. Reg. § 1.125-1(q)(1)(iv)
National Research Program (NRP)National Research Program (NRP)
� Three years – 6,000 taxpayers
� 1st since 1984
� Examinations began February 2010
� Examinations based on random selection
National Research Program (NRP)National Research Program (NRP)
Objective: Obtain trending info by category
� Worker Classification
� Fringe Benefits
� Information Reporting (i.e. Forms 1099)
� Officers’ Compensation
Alternative Dispute Resolution Alternative Dispute Resolution
