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In November 2009, the Internal Revenue Service (IRS) announced that it would begin its first Employment Tax National Research Project (NRP) in 25 years. One purpose was to gather data through audits to determine the compliance rate with employment tax laws, and estimate the cost, in the form of lost tax revenues, of noncompliance.
The IRS feels that business practices in the employment tax area may have changed significantly since the last study in the 1980s. The project began in February 2010, and will include approximately 6,000 audits during a three-year period.
The focus of the audits will be in: (i) worker classification, (ii) employee fringe benefits, (iii) reimbursed business expenses, and (iv) compensation of owners. The NRP audits will focus on 2007 and 2008 tax returns but may be expanded. Although those years have passed and cannot now be altered, doctors should revisit each of these areas to ensure they are properly handling each and retaining proper documentation.
Worker classification (employee vs. independent contractor)
The IRS takes a variety of factors into account to determine whether a worker should be classified as an employee or an independent contractor, many of which focus on the level of control the owner has over the worker. In most associateship relationships, the IRS will take the position that employee status is the proper classification.
However, there are situations in which independent contractor status is defensible. Examples include (i) an experienced doctor who sells his or her practice and continues to provide services after the sale, and (ii) a specialist who has his or her own practice, but also works out of a general practice office on certain days. Independent contractor status is most likely to succeed when the contractor operates through his or her own corporation or other entity, provides services in a variety of practices, and works without supervision from the owner (e.g., on days when the owner is not present).
Other factors supporting independent contractor status include the contractor providing his or her own staff, own supplies and instruments, and doing his or her own billing and scheduling. As to any workers treated as independent contractors, the owner should keep a file with the underlying services agreement and any information that may be supportive of independent contractor status.
Information as to how other practitioners in the area treat similar workers is valuable if there is a challenge by the IRS; it may pave the way for relief under Section 530 of the Internal Revenue Code, which includes safe harbor provisions that can prevent the IRS from retroactively reclassifying workers.
The IRS’s focus in this area will be on tax-free benefits to employees such as health insurance, medical expense reimbursements, etc. Fringe benefits for shareholders owning more than 2% of an S-corporation are not deductible by the corporation. Employers should be fully aware of what fringe benefits they provide.
Reimbursed business expenses
This category includes nontaxable reimbursements for meals and entertainment, mileage and other car expenses, travel and lodging, etc. The focus is to determine whether the reimbursed expenses are reasonable and necessary business expenses, and whether the proper documentation to substantiate such items has been received by the employer.
Compensation of officers
In the corporate context, particularly in S-corporations, the issue is whether the officers/owners of the business have been paid reasonable compensation for their services, prior to taking distributions from the corporation in a form not subject to payroll taxes (e.g., corporate dividends). The practice can create a job description that lists the various duties of the owner, and possibly have external salary information pertinent to the industry to use as a guide for the compensation of the owner. As a rough rule of thumb, the salary and benefits of the doctor should be approximately 25% to 35% of net collections attributable to him or her.
If selected for audit, the doctor should seek representation by an accountant or attorney experienced in IRS audits and not attempt to personally handle the audit. Also, if possible, the doctor should have the IRS conduct the audit at the offices of the representative.
John McGill provides tax and business planning exclusively for the dental profession and publishes The McGill Advisory newsletter through John K. McGill & Co., Inc., a member of The McGill & Hill Group, LLC, a resource for tax and business planning, practice transition, retirement planning, CPA, and investment advisory services. Blake Hassan provides legal services through McGill and Hassan, P.A, Attorneys at Law. Visit www.mcgillhillgroup.com.