The Employment Tax Audit Part 2 of 3 Part Series

Transcription

1 American Bar Association Employment Tax Section JANUARY 21, 2011 The Employment Tax Audit Part 2 of 3 Part Series Chaya Kundra, Moderator, Kundra & Associates Anthony G. Arcidiacono, Ernst & Young LLP Anita Bartels, Employment Tax Policy Vincent S. Canciello, Ernst & Young LLP Thomas M. Cryan, Miller & Chevalier* *Marianna G. Dyson, Miller & Chevalier

2 Internal Revenue Service Manual IRM Section provides that The Service is committed to evaluating and improving the employment tax program.

3 Employment Tax Examinations Determine Whether: Workers are properly classified The employment tax liability is substantially correct Information returns and wage statements have been filed properly

4 Issues 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

5 Worker Classification Determine the extent of behavioral control 1) Instructions 2) Training

6 Determine 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

7 Determine the Extent of the Relationship of the Parties 1) Employee benefits 2) Intent of the parties 3) Permanency 4) Discharge/termination 5) Regular business activity

8 Working Condition Fringe Benefit Exclusion under Code 132(d)

9 Working Condition Fringe Benefit Exclusion: Statutory Framework 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 (a)(2)

10 Working Condition Fringe Benefit Exclusion: Statutory Framework The WCF exclusion generally covers any property or services provided to an individual performing services for the employer: (IRC 132(d), Treas. Reg ) 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

11 Working Condition Fringe Benefit Exclusion: Definition of Employee Treas. Reg (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.

12 Working Condition Fringe Benefit Exclusion: Recordkeeping Requirements 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 (c)(1). If deduction is available to EE under 162 the WCF exclusion applies without regard to the 2% floor.

13 Examples of Benefits That May be Considered a 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

14 Four Hot Working Condition Fringe Benefit Audit Topics Travel expense and per diem issues (Treas. Reg (a)(1)(v) and (c)) Personal use of the corporate aircraft, including flights provided to spouses Employer-provided cell phones and cell phone service Employer-provided cars

15 Working Condition Fringe Benefit Travel Expense Reimbursement Rule of Treas. Reg (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 But, remember, an independent contractor can be an employee for WCF purposes.

16 Travel Expenses and Per Diem Arrangements: Intersection of 62(c) Rules Requirements for maintaining a Travel/Expense plan that meets the accountable plan requirements of 62(c) and Treas. Reg : 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 ( (k))

17 Recurring Issues for Travel Expense and Per Diem Arrangements 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?

18 Use of the Corporate Plane and Spousal Travel: Deduction Limitation on Spousal Travel Section 274(m)(3) disallows deductions (other than moving expenses) for spouse s/guest s travel expenses when traveling with the employee on business 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)

19 Use of the Corporate Plane and Spousal Travel: ER s s Election in the Case of Business Travel Treas. Reg (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

20 Use of the Corporate Plane and Spousal Travel: Special Valuation Rule for Personal Use 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 (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

21 Use of the Corporate Plane and Spousal Travel: Valuation 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

22 Use of the Corporate Plane and Spousal Travel: Deduction Disallowance Rules General rule: employer may deduct costs attributable to provision of fringe benefit (Treas. Reg and T) 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 and Prop. Treas. Reg set forth an allocation method based on each passenger s reason for flying rather than primary purpose test

23 Use of the Corporate Plane and Spousal Travel: Valuation 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

24 Use of the Corporate Plane and Spousal Travel: 274(e)(2) 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

25 Employer-Provided Cell Phones: Substantiation Requirements 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

26 Employer-Provided Cell Phones: Audit History IRS examination activity Numerous Tax Court decisions sustaining substantiation requirements Reference in Audit Techniques Guide on Fringe Benefits Issuance of IRS general information letter in 2007 Miller & Chevalier s Aug. 31, 2007 request for guidance under Industry Issue Resolution Program Treasury interest in issue Rep. Sam Johnson s power lunch with Paulsen in th Congress - introduction of legislative proposal

27 Employer-Provided Cell Phones: Hot Off the Press! 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.

28 Four Hot Working Condition Fringe Benefit Audit Topics: Employer-Provided Cars Automobiles are listed property under 280F 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 Determination of what constitutes a commute can be tricky!

29 Employer-Provided Cars: Special Valuation Rules Annual lease valuation ( ALV ) method Treas. Reg (d) Fleet vehicles Fuel valuation Vehicle cents-per-mile method Treas. Reg (e) Commuting valuation rule Treas. Reg (f) Special consistency rules apply to the use of any valuation rule selected by the employer. Treas. Reg (c)

30 Four Hot Working Condition Fringe Benefit Audit Topics: Employer-Provided Cars 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)

31 De Minimis Fringe Benefit Exclusion under Code 132(e)

32 De Minimis Fringe Benefit Exclusion: Statutory 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

33 De Minimis Fringe Benefit Exclusion: Statutory 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

34 De 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 (b); TAM

35 De 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

36 De Minimis Exclusion: Administrative Impracticability The second factor governing whether a benefit of small value must be taxed as wages is administrability Treas. Reg (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 (Oct. 28, 2009)

37 De Minimis Exclusion: Definition of Employee Any recipient of a fringe benefit, including family members of employees and clients/business associates. Treas. Reg (b)(3) Nondiscrimination rules also do not apply to this benefit (except in the limited case of employeroperated eating facilities as defined in Code 132(e)(2))

38 De 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 (d)(4)

39 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

40 Value: Narrow Interpretation Followed by Shrinking Valuation in IRS Informal Rulings PLR 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 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 the IRS concluded that nonmonetary achievement awards having a fair market value of $100 would not qualify as de minimis fringes.

41 Special 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 (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

42 Special Issues: Gift Cards (Continued) TAM (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.

43 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 (b)(2)(iv) (pre-1987 regulations on employee awards) and Prop Treas. Reg (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 (c)(2) Softening of IRS Position?

44 Special Issues: Employee Lotteries/Door Prizes Given the statutory prohibition under Code 102(c) of a gift characterization for employerprovided 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?

45 Special Issues: De Minims Fringe Benefit Exclusion 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 (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?

46 Special 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 (q)(1)(iv)

47 National Research Program (NRP) Three years 6,000 taxpayers 1 st since 1984 Examinations began February 2010 Examinations based on random selection

48 National Research Program (NRP) Objective: Obtain trending info by category Worker Classification Fringe Benefits Information Reporting (i.e. Forms 1099) Officers Compensation

49 Alternative Dispute Resolution (ADR) Employment Tax Options Early Referral - Rev. Proc Available before 30 day letter issued Fast Track Settlement - Rev. Proc Also available before 30 day letter issued Post Appeals Process Mediation - Rev. Proc At conclusion of Appeals process Arbitration - Announcement

50 Unagreed Employment Tax Case 30 Day Letter issued to advise taxpayer of All unagreed proposed adjustments to tax No change cases involving full disallowance of refund claim This 30 day letter is designed for specific types of cases C for worker classification and no 530 relief D for all other employment tax issues Separate letters issued when both IRC 7436 and non issues are in dispute Pub 3498 and Form Statement of disputed issues are also enclosed

51 30 Day Letter Attachments Copy of exam report Agreement forms to assess, collect and for acceptance of overassessment F 2504, for excise or employment tax F 2504-S, includes sec. 530 statement F 2504WC, in worker classification cases Protest required for all unagreed cases in excess of $25k in additional proposed tax

52 No Protest Filed IRC 7436, worker classification eligible for Tax Court Tax assessment is suspended Issued Notice of Determination of Worker Classification (NDWC notice); Letter 3523 Non-section 7436 issues Tax assessed File refund suit in District Court or Court of Federal Claims Flora Rule for refunds divisible taxes

53 Protest Filed Case sent to Appeals Appeals settles on merit or hazards of litigation If unagreed with appeals officer can request Post Appeals Mediation (PAM) If unagreed after PAM; tax either assessed for non-7436 issues or NDWC notice issued