2010 IRS Employment Tax Audits To Include Exempt Organizations

Originally published January 2010

The IRS Tax Exempt and Government Entities Division (TE/GE Division) announced that it will be conducting random employment tax audits in 2010. The audits will be conducted as part of an agency-wide effort of the IRS to track compliance with employment tax regulations among all filers of employment tax reports. The TE/GE Division reported that for the first time, the project—known as the Employment Tax National Research Project— will include audits of exempt organizations. According to the TE/GE Division Commissioner, some 500 audits of exempt organizations can be expected.

The IRS explained that underreporting of employment taxes is a large part of the tax gap— employment tax misreporting totals about $54 billion a year—and accordingly this is a target issue for the IRS. Members of Congress are also concerned about misclassification of workers. Pending legislation, introduced in December 2009, if adopted, would require employers to file additional information with the IRS when claiming independent contractor status for their workers.

Audits To Focus On Worker Classification

As a starting point, the IRS has stated that it will determine whether audited organizations have correctly classified workers as employees or as independent contractors. Failure to properly classify a worker as an employee—and to accordingly withhold, report and pay over income and Federal Insurance Contribution Act (FICA) taxes—could give rise to significant tax and legal implications. For example, an organization may be held liable for failure to withhold income and FICA taxes, plus interest and penalties, if an independent contractor is reclassified as an employee. Misclassified workers may also be entitled to retroactive participation in qualified pension plans (e.g., 401(k) plans, pension plans, and profit-sharing plans) and welfare benefit plans (e.g., cafeteria plans, group health insurance plans, and group life insurance plans), which can be costly for an organization.

Additional Risks For Exempt Organizations

For exempt organizations, employment audits could present additional risks as IRS agents may consider other employment-related tax issues that arise in the exempt sector. For example, on watch for excess benefit transactions, agents may examine reasonableness of compensation and adherence to expense reimbursement policies.

Economic benefits (which include payments of wages as well as deferred compensation, provision of...