In February, the IRS will launch the largest employment tax audit in 25 years in an effort to close the "tax gap," the difference between the amount of employment taxes owed and the amount actually collected. This effort comes after a 2005 study revealed that employment taxes are the second largest "tax gap" contributor. A total of 6,000 businesses will be affected by the audit.

The IRS will conduct this audit by randomly selecting 2,000 businesses of all sizes each year for the next three years, including both non-profit and for profit businesses. The audit will focus on the following five major issues and will target the 2007 and 2008 tax years:

• Worker classification (employee v. independent contractor)
• Executive compensation (reasonableness)
• Fringe benefits (common examples include health and other benefits, employee discounts, personal use of company vehicles, employer provided meals and housing, educational assistance and stock-based compensation)
• Non-filers
• Reimbursed expenses

Employers cannot avoid being selected for this audit, but they can prepare for it and implement measures to ensure a smooth audit. First, legal commentators suggest employers review current payroll procedures in the targeted audit areas. Employers can also start compiling files that could be requested in an audit and review documents for information that might be protected by the attorney-client privilege. Special attention should be given to the last three years' tax returns as well as the supporting documentation for the returns. Additionally, employers should consider developing a clear chain of command to respond to the IRS. If an employer is audited, the employer should obtain assistance from expert advisers, such as legal counsel, as soon as possible in the process.

If you have any questions about employment taxes, your payroll procedures, or what to do in the event of an IRS audit, please contact the labor and employment attorneys at Bingham McHale for more information.

Other Stories: