IRS scrutinizes payroll practices, challenges for companies.

• Author: Bailor, Bernard
• Position: TAX AUDIT - Internal Revenue Service

About 6,000 companies nationwide are being selected at random for a payroll tax audit. The audits will focus on whether companies are paying all of their required employment taxes that fund Social Security and Medicare. The Internal Revenue Service wants to know how many companies are misclassifying employees as independent contractors and failing to pay taxes on fringe benefits. The initiative is expected to last for three years.

It is likely that the IRS will find many companies in violation of regulations concerning how workers are to be classified for payroll tax purposes, as there is a clear incentive to classify employees as independent contractors.

Companies are required to pay half of their employees' 12.4 percent Social Security and 2.9 percent Medicare tax. However, if the employee is misclassified as an independent contractor, the company does not pay these taxes.

The IRS estimates that companies underpay approximately $14 billion annually by misclassifying employees as independent contractors. The recent economic recession will most likely increase the pressure on companies to avoid these payroll taxes.

A failure to pay penalty is commonly assessed in these situations, which can be costly--at up to 25 percent of the unpaid tax liability.

[ILLUSTRATION OMITTED]

In addition to imposing civil penalties, if the IRS believes that fraud was involved in the payroll...