A few weeks ago I wrote about a case I recently won in the United States Tax Court. There has been movement since then and because it affects so many of us I wanted to keep us all updated, especially small businesses who can really benefit from it.
Here is the situation.
Typically the IRS audits us and proposes a tax due, normally because it disallows some of our expenses or picks up income we mistakenly failed to report. These are routine audits.
Sometimes the IRS audits are more complex, we reported the right amount of income and the right amount of expenses but complex tax rules cause additional taxes to be owed. For example, someone in the real estate business may form a limited partnership to reduce personal liability, but thereby cause the passive loss rules to kick in and we may lose some of our deductions.
And then there are employment tax audits. Here the IRS collects the same payroll taxes twice, once from the employer and once again from the employee. These are especially harsh audits and the subject of the Tax Court case.
Briefly, the IRS has undertaken an extensive program to reclassify independent contractors as employees because doing so generates revenue for the government. The reclassification allows the IRS to collect the same taxes twice. It collects once from the independent contractor when he files his tax return and reports his 1099 income. It collects once again when the IRS forces the employer to reclassify that independent contractor as an employee and then pay all back payroll taxes, plus penalties and interest, for the last three years. Thus the IRS is collecting the same taxes twice.
In an incredibly important decision, last month the entire United States Tax Court, all 16 judges acting unanimously, issued a ruling that essentially prevents the IRS from collecting employment taxes twice. From now on the government has to simply search its files and if the independent contractors have reported their form 1099 income on their returns then the IRS could not collect those payroll taxes from the employer a second time.
This is an incredibly important case and involves a great deal of money that the IRS collects improperly every year.
One would think that the IRS would simply modify its audit procedures so that the auditor would simply search their computer files during the audit to make sure they don’t pick up the same worker income twice.
Instead, the IRS has issued a new proclamation that it will abide by this case only if it is in Court and not at the audit or appeals level. Now I want to say this again for emphasis. The United States Tax Court, acting unanimously, all 16 judges signing the opinion, ruled that the IRS must now essentially remove those double taxed workers. The IRS is now seeking to do so generally only if the employer requests it in Court and not during the administrative hearings.
I think this gives you an insight into the harsh mentality of IRS management.
Here is my prediction.
The IRS pronouncement will never work. If we taxpayers know this case, then we will always appeal IRS employment tax audits to the Tax Court. The already overworked IRS attorneys will then be covered up with pretrial discovery to remove the double taxation. The attorneys will then be forced to send the case back to the auditor to search its computer files and remove the double taxed workers-as it should have done originally.
I think the IRS knows this but is hoping that employers are unaware of this case and instead can be pressured to settle without going to Court.
I have spoken to a high level IRS person and the consensus is the Service’s pronouncement is ridiculous.
So folks, here’s the deal. The facts of this case are commonplace, every single employee reclassification audit, of which there are thousands ongoing at any one moment, involves this issue. Smart employers may cite this case and tell the IRS auditor to comply at the audit level (they will have to ask the IRS attorneys) and thereby save all parties a lot of time and money and especially taxes.
So there you have it. Don’t roll over and be a victim. This is an important case, so important that the entire Tax Court acting en banc ordered the IRS to essentially cease collecting the same taxes twice. You can bet every IRS employment tax auditor knows of the case and will comply-but only if you know of it too.
David Leeper is a Board Certified federal tax attorney with 38 years of experience. He can be reached at 915-581-8748, by email at firstname.lastname@example.org, or visit leepertaxlaw.com