IRS Mobilizes For Employment Tax Audits

The IRS has initiated a National Research Program (NRP) aimed at closing the “tax gap” in employment tax matters. The Service has randomly selected 6,000 taxpayers to “participate” in the program, some of whom might then graduate to full-blown employment tax audits. Employment tax issues are especially problematic due to the frequency with which you must file returns, which increases the risk of error, and the draconian “trust fund” penalty that can be imposed for willful violations of the withholding rules.

The study will focus on traditional payroll issues such as withholding and the classification of de-facto employees as “contractors”, officer compensation programs, employee expense reimbursement programs, timely reporting and payment of payroll tax and so forth.

Another area to be examined that is particularly important for aircraft owners is the treatment of fringe benefits. The fringe benefit valuation provisions – the “SIFL” rules – governing certain types of personal aircraft use require extensive record-keeping and calculation to determine the correct amount of “compensation” a “specified individual” should receive for such use. Thus, if an executive is supposed to receive SIFL income, it should come as a part of his or her paycheck from the company (from which FICA taxes are withheld), and not be treated as a return of capital or 1099 income. This could be especially problematic for owner-pilots, whose small businesses may or may not be compensating their officers as employees (itself a tricky area for another day).

Timing is also an important element in properly treating SIFL income as “compensation”. One calculates SIFL compensation on a fiscal year, that is, you can elect to “run” your flight logs for the period beginning November 1 of the preceding year to October 31 of the following year. If the imputed income is to be added to the payroll, therefore, you generally have only about a month to get it done. A scramble under the best of circumstances.

So, what to do, what to do? The obvious (and legally correct) answer is to keep contemporary records so that most of the data is in place by the end of October, and you can run your fringe benefit through payroll by the end of the year. Failing this, however, consider the following approaches with your tax professional:

(1) Withhold employment taxes on an estimated amount of SIFL income, perhaps based on prior years’ usage. While the number may not exact your good faith effort goes to the materiality of any tax error (if you don’t withhold enough);

(2) Recognize your fringe benefit income the following year (if you must). Even if late this is consistent with the rule that the fringe benefit is treated as “compensation”;

(3) If the company issues the specified individual a 1099, carefully document how this “income from self-employment” is taxed.

– Ari Good, Esq.