The Internal Revenue Service recently announced an initiative to target the federal tax returns of 6,000 companies in the next few months. These audits are intended to "study" compliance in the areas of payroll taxes, independent contractor status, fringe benefits and executive compensation. The primary audit goals include reducing the tax gap by increasing tax compliance and payroll tax collections, and reducing the number of "misclassified" independent contractors.

Most companies have never been subjected to a payroll or targeted tax audit, even though payroll taxes account for more than 70 percent of federal tax revenues and are now a Tier 1 audit issue. Those companies that have been audited are typically surprised at the scope, far-ranging issues and unique procedural nuances associated with these audits.

To proactively address this IRS audit initiative, employers should consider conducting their own compliance reviews. Conducting a compliance review allows a company to evaluate the targeted audit issues on its own terms. It also assesses exposure and examines the eligibility criteria for the three separate relief provisions available for independent contractor issues, fringe benefit issues and payroll taxes.

Being proactive offers companies an opportunity to fix problem areas before the IRS arrives. While conducting such a review, however, every effort should be made to protect the privileged status of the compliance review and any other preparations that would make the organization audit-ready.

-- John Ferreira,
jferreira@morganlewis.com,
Morgan Lewis & Bockius LLP

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