Most payroll tax audits are straightforward and involve the examination of the business books and records to ensure that the correct amount of wages was reported. However, oftentimes, this quickly turns into “reclassification audit” where the taxing agency challenges payments made to independent contractors as wages paid to employees resulting in a demand for a substantial amount of additional tax, penalties, and interest – and the penalties can be substantial in amount relative to the wage amounts. In addition, an IRS payroll tax audit can also trigger a state payroll tax audit and vice versa.

Most payroll tax audits arise when a person paid as an independent contractor suddenly files a claim for unemployment, a disability claim, or a workers compensation claim with the state. However, many states target businesses with a higher propensity of paying workers in cash – restaurants, bars, construction, and businesses that utilize “seasonal” workers, etc. In addition, many times, if one worker from a particular class of payees is reclassified, the state may attempt to reclassify the entire class as employees as well.

The payroll tax auditors have years of experience identifying payees for reclassification; therefore, it is imperative that your business be represented by a competent payroll tax attorney immediately when you are first notified of a payroll tax audit. Importantly, although the laws regarding classification of someone as an independent contractor versus an employee for state payroll tax purposes are similar to the laws followed by the IRS, they are not identical. For example, some state tax agencies focus more on the right of the principal to control the manner, mode, method and means of performing the details of the work performed. The IRS on the other hand, generally applies a 20-factor test based upon Common-Law Rules with a focus on classifying the nature of control into three groups: – Behavior Control, Financial Control and Type of Relationship Factors.

Our payroll tax attorneys are well versed in payroll tax laws, each state employment tax agency’s procedures and the various state nuances that may cause someone classified as an independent contractor by the IRS to be treated differently by the state and classified as an employee. For example, in some states, unlicensed sub-contractors are automatically deemed employees even though they otherwise satisfy all the tests for independent contractor status.

Our expertise enables us to apply the 20 common law factors to the facts of each case in a manner which will most likely yield an independent contractor status finding. We do so by developing witness testimony and other documentary evidence consistent with the factors supporting a lack of control. Moreover, in the event we disagree with the state taxing agency findings, our payroll tax lawyers can appeal your case to an administrative law judge and file legal briefs to support the appeal.

Finally, having our payroll tax attorneys involved in your payroll tax audit at the inception, can prove instrumental in preventing a finding of fraud if your business pays workers in cash and fails to file 1099 forms or otherwise conceals the workers existence.

If the taxpayer is a corporation and does not pay over the payroll taxes due, oftentimes the IRS or state taxing agency may hold the corporate officers or persons responsible for nonpayment of the corporate payroll taxes individually liable. In the case of the IRS, Internal Revenue Code section 6672 imposes a trust fund recovery penalty, against all persons found to be responsible, in an amount equal to 100 percent of the portion of the payroll taxes withheld from the employees. Unlike the IRS, many state taxing agencies impose liability not only for the “trust fund” taxes withheld from employees, but also the entire amount of state employment taxes – including penalties and interest. For the IRS and the states, our payroll tax attorneys are often able to prevent this from occurring by establishing that the responsible person did not act “willfully.” And where the taxing agency does not agree, these payroll tax claims stemming from the reclassification audit may nonetheless be dischargeable in bankruptcy since the taxes were never “collected or withheld” enabling our payroll tax attorneys to attack the “willfulness” element.