Common Audit "Red-Flags" for Tax Authorities
Certain signals in a professional contractor's tax return may trigger the IRS to implement a non-compliance audit.Re-appointment of retired employees as 1099's:
Companies frequently need to hire personnel on a temporary basis, to complete projects or input specialist knowledge. In many cases an retired employee is best qualified to work with proprietary systems and long-term projects. Re-appointment as an employee will usually compromise eligibility for pension plans, so will not be regarded as an option by the returning retiree. Appointment as a 1099 contractor will almost always breach IRS and state rules if the retiree is returning in the same capacity as when they were an employee, and offering similar services. Where an individual furnishes the IRS with a W2 and 1099 for the same company, an investigation by the IRS or State authorities will ensue.
Employment of recently created single employee Corporations:
Although long considered a legitimate means of achieving compliance, more recently tax authorities have re orientated, and broadened their area of concern to include recently formed corporations with a single employee. Tax Authorities will disallow these on the basis that they were created specifically to reduce tax obligations. Although a costly and disadvantageous option for a single independent contractor, Incorporation has seemed to offer a valid pathway to increased employment opportunity. However internal IRS audit documents show that in Alaska, California, Ohio, Minnesota, New York, and New Jersey, IRS auditors, as recently as last year, hunted for corporations created by computer programmers and other technology professionals. Many such corporations were disallowed for tax purposes on the basis that they were less than 1 year old and had only one employee. The audit documents evidencing this were made available by Harvey J Shulman, a Washington lawyer for the National Association of Computer Consultant Businesses.
Applications for Unemployment Benefits or Workers Comp by independent contractors:
An application at any time by any Independent Contractor for Unemployment benefits or Workers Compensation will almost certainly result in an investigation into the circumstances of that individual's employment with all client companies. This type of inconsistency is exactly the kind of lead that is searched for by tax authorities to implement a company-wide compliance audit and is one of the most common triggers. Any successful claim will not be covered by a companies current unemployment or workers compensation policies. A claim by one independent contractor within the state typically triggers the investigation of all worker in similar positions within the state
Legal action taken by Contractors for benefits:
One-time contractors have successfully filed charges against their clients claiming coverage as an employee under many labor laws including minimum wage, overtime and non-discrimination laws. The anomalies implied by this action on the part of the contractor will attract the interest of tax authorities to determine the true nature of the agreement between contractor and client company and conditions of work.
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