Audit PitfallsJason E. RussellDeloitte Tax LLPOctober 8, 2015

330p

Agenda• Non-cash Fringe Benefits

• U.S. Payroll Deposit Rules & Equity Transactions

• Service Provider Documentation

• Worker Classification & Settlement Program

Fringe Benefits

W-2 inclusion is correct for many of theseFringe benefits: Be cautious of these

Awards and prizes Gift cards Ipod, ipad, raffle prizes

Award trips “President’s Club, Diamond Club, Century Club” Spousal accompaniment on award trips

Loans Date of hire payments: is forgiveness planned?

Company cafeteria Subsidy (reduced price) is OK; free is not OK

Wellness program cash-equivalent incentives Subsidized gym dues Relocation

Househunting trips are taxable Commuting is taxable, even if done via flight

Employee discounts 20% OK on services Gross profit % OK on goods

4

Equity Deposit Timing

Payroll Deposit TimingParticularly for equity transactions, but these apply to all payroll liability events

6

Deposits due that Friday

Deposits due the following Wednesday

Next (Business) Day$100,00

0

Wed-Fri

Sat-Tues

Depends on the Type of Equity What’s the Payroll Liability Date?Stock Options

• Vesting date of the shares

• Date of 83(b) election, if one is madeRSAs

• Exercise date

• See IRS Memo, which provides for transaction + 3 days to settle (up to that), and another day for the deposit to credit

RSUs• Settlement date (net shares to participant accounts)

• See also: theory behind IRS memo, even though language of memo only applies to stock options

◦ On March 14, 2003, a Memorandum was issued by the IRS to audit examiners to provide guidelines surrounding assessment of employment tax penalties for NQSOs. “It has been argued that the shares (or the value of the shares) are not available to the

exerciser of the options until settlement date, and therefore no actual or constructive payment of wages takes place until that time.

There is generally only a three day delay between time of exercise and time of settlement resulting from such exercise. In fact, under 17 C.F.R. Sec. 240.15c6-1(a), the SEC generally established a maximum three day settlement period for broker- dealer trades. There is presently no specific published guidance relative to whether the date of exercise or date of settlement is the appropriate date for considering assertion of the penalty for failure to deposit employment taxes attributable to the exercise of nonqualified stock options.”

◦ Under this Field Directive, auditors “should not challenge the timeliness of deposits required under Treas. Reg. § 31.6302-1(c), if such deposits are made within one day of the settlement date, as long as such settlement date does not fall more than three days from date of exercise.”

Field audit memorandum

Payroll Deposit PenaltiesBased on calendar days, not business days

9

More than 15 days late

6-15 days late

1-5 days late2%

5%

10%

Domestic Business Travelers

FL

NM

DEMD

TX

OK

KS

NE

SD

NDMT

WY

COUT

ID

AZ

NV

WA

CA

OR

KY

ME

NY

PA

MI

VT

NH

MA

RICT

VAWV

OHINIL

NCTN

SC

ALMS

AR

LA

MO

IA

MN

WI

NJ

GA

DC

AK

HI

Which jurisdictions are the most active in audit of non-local companies?

Service Provider Documentation

Non-US service providers

◦ Employee v. Contractor

◦ Treaty Considerations (Dependent v. Independent personal services)

◦ Totalization agreements for social taxes

◦ Certification of non-US status

Form 8233 W-9 W-8BEN

XX%Supporting text or key insight runs

here

Requiring proof of this is a recurring audit topic for the IRSService Provider DocumentationForm W-9

• Used to support US taxpaying vendor providing services in the US.

• Technically, original W-9 not required at vendor setup, contract initiation (except for interest, dividends

• Upon receipt of taxpayer ID mismatch from the IRS, original “wet signature” W-9 should be provided to you by the service provider. Backup withholding should begin between notice by the IRS of mismatch and the provision of updated information.

Form W-8BEN• This is often provided by non-resident contractors performing services in the US

• Supports 1042-S reporting

Form 8233

• Non-US resident contractors performing services in the US

• Provides reduced or no withholding on the income provided to them.

• Annual form

• Supports 1042-S reporting

• Must provide a certified TIN for payments of interest, dividends or other payments that are subject to broker reporting, and after receipt of B notice

• For all other payments, the TIN may be provided in any manner. Verbal is acceptable in some cases, however, a log of these calls is required to be maintained

• Payer may require a signed form W-9 from U.S. exempt recipients to overcome a presumption of foreign status

• Non U.S. recipients would not provide a Form W-9, but instead provide a Forms W-8 or Form 8233

• Disregarded entity: provide name/TIN that would be on tax return

Confirming the payee status

Obtain documentation (e.g., Form W-9, Forms W-8 or Form 8233) from payee to determine their residency status. You may rely on representations on the statement unless form is invalid on its face or you have knowledge or reason

to know the form is incorrect

Best Practice is to always request a signed tax form

Form W-8BEN: Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals)

Purpose• Establish foreign status• To claim a reduced rate of, or exemption from,

withholding tax as a resident of a foreign country with which the United States has an income tax treaty

• Claim status as the beneficial owner of the income for which the form is being furnished

• Claim exemption from Form 1099 reporting and backup withholding for income that is not subject to NRA withholding

Who and When• A foreign individual that is a beneficial owner of

income should provide Form W-8BEN to the withholding agent or payor

• This form should be provided at least every three years by the payee

• This form should be updated within 30 days of a change in circumstances or address

Validity Period• Generally, a Form W-8BEN provided without a U.S. TIN

will remain in effect for a period starting on the date the form is signed and ending on the last day of the third succeeding calendar year, unless a change in circumstances makes information on the form incorrect

Form 8233 - Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual. Used most commonly by NRA independent contractors to obtain reduced withholding

Purpose• Establish foreign status for independent services (e.g.

non-U.S. independent contractor working in the U.S.)• To claim a reduced rate of, or exemption from,

withholding tax as a resident of a foreign country with which the United States has an income tax treaty

Who and When• A foreign individual that is a beneficial owner of

independent personal services income• This form should be provided every year by the

payee• This form should be filed with the IRS

Form W-8BEN-E: Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities)

Purpose• Establish foreign status• To claim a reduced rate of, or exemption from, withholding

tax as a resident of a foreign country with which the United States has an income tax treaty

• Claim status as the beneficial owner of the income for which the form is being furnished

• Claim exemption from Form 1099 reporting and backup withholding for income that is not subject to NRA withholding

• Certify FATCA classification (to be addressed in next section)

Who and When• A foreign entity that is a beneficial owner of income

should provide Form W-8BEN to the withholding agent or payor

• This form should be provided at least every three years by the payee

• This form should be updated within 30 days of a change in circumstances or address

Validity Period• Generally, a Form W-8BEN provided without a U.S. TIN

will remain in effect for a period starting on the date the form is signed and ending on the last day of the third succeeding calendar year, unless a change in circumstances makes information on the form incorrect

◦ On March 14, 2003, a Memorandum was issued by the IRS to audit examiners to provide guidelines surrounding assessment of employment tax penalties for NQSOs. “It has been argued that the shares (or the value of the shares) are not available to the

exerciser of the options until settlement date, and therefore no actual or constructive payment of wages takes place until that time.

There is generally only a three day delay between time of exercise and time of settlement resulting from such exercise. In fact, under 17 C.F.R. Sec. 240.15c6-1(a), the SEC generally established a maximum three day settlement period for broker- dealer trades. There is presently no specific published guidance relative to whether the date of exercise or date of settlement is the appropriate date for considering assertion of the penalty for failure to deposit employment taxes attributable to the exercise of nonqualified stock options.”

◦ Under this Field Directive, auditors “should not challenge the timeliness of deposits required under Treas. Reg. § 31.6302-1(c), if such deposits are made within one day of the settlement date, as long as such settlement date does not fall more than three days from date of exercise.”

Field audit memorandum

◦ Underpayment penalty2% — One to five days late;

5% — Six to 15 days late; and

10% for more that 16 days late

◦ Weekends and holidays are included when calculating penalties

Penalties

◦ The IRS uses a First In First Out system to assign deposits, and will attribute a deposit to the most recent tax liability, even if a deposit was missed and the deposit actually relates to a later-dated liability. Unfortunately, this can cause a cascading penalty.

◦ Taxpayers can designate to which tax period they want a specific deposit applied within 90-days of receipt of a notice of penalty.

◦ The IRS does allow a “safe-harbor” shortfall if the shortfall is no more then the greater of $100 or 2% of the amount due, so long as the original deposit is made timely, and the shortfall is made up by the ‘make-up date.’ Example: A is required to make a deposit of $1,000 on June 15 and is a semi-

weekly depositor. A makes a deposit of $900 on June 15 and would be required to make the additional $100 deposit by the first Wednesday or Friday occurring on our after July 15th. Because the shortfall is $100 and they have made up the deposit by the make-up date, no penalties are assessed.

Penalties

Worker Classification Settlement Program

• Project workers are not employees

• Temporary workers are not employees

• Former executives returning as “consultants” are independent contractors

Common misconceptions of worker classification

1. Instructions

2. Training

3. Integration

4. Personal services

5. Hire, pay assistants

6. Continuing relations

7. Set work hours

8. Full time required

9. Employer’s premises

10. Order, sequence set

11. Oral, written report

12. Hour, week, month pay

13. Business expense pay

14. Furnish tools and materials

15. Significant investment

16. Realize profit, loss

17. More than one employer

18. Services available to public

19. Right to discharge

20. Right to terminate

Rev. Rul. 87-41 — Twenty common law factors

IRS 2006 audit manual on worker classification

• Created 3 categories of evidence:• Behavioral control• Financial control• Relationship of the parties

Worker classification “Red flags”

• Former employees• Form 1099 & Form W-2• Form 1099 – Multiple years• Industry focus• Leads

‒ IRS internal database‒Contractor originated‒State info sharing

◦ Is there a web presence for the contractor?◦ Does 100% of work come from single source?◦ Who pays any assistants? The contractor directly or

the company?◦ Paid hourly or by the job?◦ Expenses paid separately or part of the overall fee?

Facts & Circumstances Considerations

E.g. Tax Year 2013

3509(a) Rate -1099

3509 (b) Rate –No 1099

ER Share of FICA 7.65% 7.65%

EE Share of FICA 1.53% (20% of 7.65%)

3.06% (40% of 7.65%)

Total FICA 9.18% 10.71%

ITW 1.50% 3.00%

Total 10.68% 13.71%

Tax rate comparison

No Relief

Section 530 Relief

CSP 1 YR (audit)

CSP 25% (audit)

VCSP 10% (no audit)

Tax Rate 13.71% + Penalties and interest

N/A 10.68% 2.67% 1.07%

◦ A new program that allows employers to resolve past worker classification issues at a reduced cost by voluntarily reclassifying their workers

◦ Available to businesses, tax-exempt organizations and government entities that currently erroneously treat their workers as independent contractors, and would like to correctly treat them as employees in the future

Voluntary worker classification settlement program

◦ To be eligible, an applicant must: Consistently have treated the workers in the past as nonemployees

Have filed all required Forms 1099 for the workers for the previous three years

Not currently be under audit by the IRS, and not currently be under audit by the DOL or a state agency concerning the classification of these workers

Eligibility for Voluntary Program

Jason RussellDirectorDeloitte Tax LLP+1 415.783.5376jasrussell@deloitte.com

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