The Library

What To Do When The IRS Comes Knocking

The IRS will soon conduct 6,000 employment tax audits over a three-year period. The first group of audit letters should go out this or next week. During the audits the IRS will review records related to employment tax returns and will look for issues involving worker classification, fringe benefits such as the use of company cars, executive compensation, and the reasonableness of compensation. The IRS has said the audits will be conducted by its most experienced agents who have been especially trained for these audits.

According to the IRS, companies will be selected at random. Thus, there is little to be done to avoid an audit. There are, however, ways to prepare for the audit if the IRS comes knocking.

Here are some tips to follow if selected for an audit. First, establish a team that is responsible for the audit. This could include legal and outside counsel, personnel from payroll, accounting, human resources, and your auditors. You should appoint one individual who will be primarily responsible for all aspects of the audit and, together with your attorneys, be the sole contact between the company and the IRS. That person will identify those responsible for gathering information and documents, organize all responses, review all documents for privilege, trade secrets or other confidential issues, and generally coordinate all aspects of the audit. That person should be present when the IRS interviews your employees. In that way you can be sure the company’s response is accurate, consistent, and complete.

You are generally required to provide the IRS with all the information it is legally allowed to request that is not privileged. You do not, however, need to provide more than the documents that the IRS specifically requests. You should retain a mirror copy of all documents you furnish to the IRS.

You should involve legal counsel if you wish to retain attorney/client privilege. In addition to helping you with your responses, counsel can assist you with identifying whether a certain document should be turned over to the IRS. Outside counsel should therefore be retained early in the process.

You do not need to feel pressured. You can generally ask for additional time to respond. You may also be able to limit the scope of the documents or information requested.

The best way to prepare for the audit is to conduct your own compliance review and correct any deficiencies. You should focus on independent contractors and other worker classification issues, compensation for officers and owners, fringe benefits such as the personal use of company cars, and payroll taxes.

A primary focus of the audit will be worker classification. You should be ready to demonstrate your reasons for classifying any individual as an independent contractor.

If you maintain nonqualified deferred compensation plans, make sure they are in full compliance. The IRS has issued two correction programs that can be used to correct errors. It is recommended that you review your plan terms in light of these correction programs to ensure that you comply with the strict requirements of Internal Revenue Code Section 409A.

For more information, please contact:

Sarah Lockwood Church 412 394 7731 schurch@thorpreed.com

Kristen Belz Ornato 412 394 7749 kornato@thorpreed.com

Paul A. Kasicky 412 394 2441 pkasicky@thorpreed.com

Kevin A. Wiggins 412 394 2401 kwiggins@thorpreed.com

This Thorp Reed & Armstrong, LLP Communiqué is prepared in summary form and should not be construed as legal advice or opinion on any specific fact or circumstance. We do not assume any responsibility to revise this Communiqué if there are subsequent changes in the law.

#01091549 February 2010