The Nuts and Bolts of Payroll Taxes in New Jersey
Paul Dougherty, CPA, MST, J.D.
AGENDA
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Definition of employee
Independent contractors
How to deal with the IRS
Questions
Who Is an Employee?
A. Statutory Employees
B. Independent Contractor vs. Employees
C. Statutory Nonemployees
Statutory Employees
Workers engaged in the following occupations are considered
to be employees by statute for social security tax
purposes, and in some cases for FUTA tax purposes (if
certain requirement are met):
1. Officers of corporations;
2. Agent-drivers and commission-drivers;
3. Full-time life insurance sales person;
4. Homeworker; and
5. Traveling and city salespersons.
Officers of a Corporation
 An officer of a corporation is generally an employee. This
is the case even if the duties are performed on a part-time
basis. However, an officer who does not perform any
services as an officer or performs only minor services is
not considered an employee if he neither receives nor is
entitled to receive any remuneration, directly or indirectly.
Statutory Non-Employees
 Qualified real estate agents and direct sellers are treated
as self-employed if substantially all their income is from
sales and they work under contract providing that they are
self-employed for federal tax purposes.
Qualified Real Estate Agents
 “Qualified real estate agents” are defined as licensed real
estate agents, substantially all of whose remuneration is
directly related to sales or other output and who perform
services pursuant to written contracts that specifies that
they will be treated as self-employed.
Employee vs. Independent Contractor
 Compensation paid to workers is subject to federal
employment taxes (FITW, Social Security, and FUTA
taxes) only if the workers are considered to be employees.
 Compensation paid to independent contractors is not
subject to the three employment taxes.
The Common-Law Test for Employee Vs.
Independent Contractor Status
An individual is employee of person for whom he performs
services if a common-law employer-employee relationship
exists between parties. Under common-law test, an
individual is an employee if individual is under direction
and control of party for whom services are being
performed.
The following is a list of the 20 factors used in
common-law tests:
1. Compliance with instructions
2. Training
3. Integration with business
4. Personal rendition of service
5. Hiring, supervising, and payment of assistants
6. The existence of a continuing relationship
7. Set hours of work
8. Exclusive full-time work
9. Work on employer’s premises
10.Sequence of work done
The following is a list of the 20 factors used in
common-law tests (continued):
11. Report required
12.
13.
14.
15.
16.
17.
18.
19.
20.
Payments by hour, week, or month
Expense account
Tools and material supplied
Facilities furnished
Risk of Loss
Number of “employees
Availability to general public
Power to fire
Termination damages
Save Haven Rule
 A safe haven rule minimizes the uncertainty of employers
in determining whether workers are employees or
independent contractors.
 This rule relieves taxpayers of potential liabilities based on
employment tax status reclassification.
Safe Haven Rule
Under the safe haven rule, a worker will not be treated as an
employee if
(1) a consistency requirement is met under which:
(a)the worker and similarly situated employees must not
have been treated as employees for any period
beginning after 1977 and
(b)the employee taxpayer did not file the applicable
federal employment tax returns (including information
returns) that would ordinarily be filed with respect to
the worker if her were an independent contractor, and
(2) the employer had a reasonable basis for not treating the
worker as an employee.
Common-Law Test in Particular Occupations
 Application of common-law factors to any particular job
situation to determine employee/independent contractor
status is an inexact process by which special
characteristics peculiar to each job are weighed against
general rules.
Common-Law Test in Particular Occupations
Insurance Agents
 An insurance company branch broker-manager is an
employee under the common-law test where he is subject
to detailed supervision and control over the manner in
which he performs his services. If certain factors are not
present, the branch manager is considered an independent
contractor and his compensation is not subject to the
federal employment tax laws (SS, FUTA, & FITW).
Common-Law Test in Particular Occupations
Salesperson and Broker
 The status of certain salespersons is determined by
statute. Salespersons who qualify as full-time traveling or
city salespersons are employees; qualified real estate
agents and direct sellers are considered self-employed.
 If a salesperson does not meet any of the above
definitions, that person’s status is determined under the
common-law test. The term “salesperson” embraces a
wide variety of occupations; the particular factors that are
important in determining an individual’s status vary
accordingly.
How to Deal With the IRS
A. How to Request a Ruling From the IRS
B. Audit Triggers
C. How to Handle an Audit
D. Trust Fund Recovery Penalty
How to Request a Ruling From the IRS
 A taxpayer can apply to the IRS Associate office for a
ruling regarding tax consequences of specific set of facts
proposed by taxpayer.
 A ruling will generally not be issued if the taxpayer’s
return is under audit but IRS may issue technical advice on
the matter.
 A taxpayer may also obtain information or determination
letters from local IRS offices if issue upon which advice is
requested relates to clearly established principal of tax
law.
How to Request a Ruling from the IRS
(continued)
 Where a taxpayer is not under audit and desires
information as to his tax status, he can make inquiries or
requests to the Director of the appropriate functional unit
of the IRS who can issue information or determination
letters by applying the statutes and tax treaties,
regulations, revenue rulings, and other precedents
published in the Internal Revenue Bulletins.
 An actual ruling can only be issued by the Associate Office.
Revenue Rulings
 The IRS uses it’s revenue ruling program as a method of
disseminating interpretations of the statute and
regulations which are of interest to taxpayers in general.
 Revenue rulings are carefully reviewed before being
published because they may be used as precedent in other
cases where the facts or issues are the same.
Audit Triggers
 There is only a small classification and selection program
for employment tax returns. In many cases, employment
tax returns are examined only as adjunct to income tax or
exempt organization return audits.
 The IRS devises an audit strategy for each type of tax
return. The percentage of returns selected for audit in
each category of tax return, called the “audit selection
rate” for that return category, depends on the sheer
numbers of returns filed in that return class and on the
IRS allocation of audit man-hours.
Audit Triggers (continued)
 The biggest allocation of resources is devoted to individual
income tax returns, where the selection rate is fairly low
(0.77%) but where over 90% of all audits were conducted
for calendar year 2003.
 The next two most important targets of the IRS audit
program are estate tax returns and corporate returns.
 The audit selection rate for employment tax returns Forms
940 through 943 has never exceeded 1% in the last five
years.
Audit Triggers (continued)
There are three areas of IRS concern in the field of
employment tax examinations
 First, taxpayers who have not filed
 Second, an item on a return which increases the chances
of audit. This area involves employee fringe benefits as
they affect the wage base on which social security and
FUTA taxes are computed.
 Third, misclassification of employees as independent
contractors.
How to Handle an Audit
 How an employer handles audit of his employment tax
return depends on the type of audit that takes place and
where it takes place.
 By being aware of the issues that are likely to be raised
during the course of an audit, the employer and his tax
representative can take steps to reduce the likelihood that
an in-depth employment tax examination will take place in
conjunction with the taxpayer’s income tax or exempt
organization return.
Types of Employment Tax Examinations
The Large Case Audit
 This program was designed to deal with increasingly large
and diversified business entities with complicated
organizational structures and business practices, and with
plants, divisions and subsidiaries located across the nation
and in many foreign countries.
The Package Audit
 Agents and auditors assigned to office or field audits of
income tax cases have been trained to be aware of
possible employment tax issues that may arise in
conjunction with the audit of corporate, exempt
organization, and individual business returns.
How Thoroughly Will the Return Be
Examined?
 The degree to which an employment tax return will be
scrutinized depends on time constraints as well as the
employment tax expertise of the examining agent or
auditor.
 An office audit of an individual’s tax return is handled by
an agent who generally has received less training in
employment tax issues.
 A field examination in the employer’s office is conducted
by an agent who has had substantially more training in
employment tax issues.
When is the Employer Safe from Additional
Tax Assessments?
 The IRS has three years after the filing of a tax return to
issue a deficiency notice or to assess penalties and taxes
in addition to those shown on the return. However, if the
return is filed prior to its original due date, then the three
year period runs from the date the return is due, not the
date the return is actually filed.
 There are some exceptions to the three-year time limit,
such as fraud.
 The IRS may seek the taxpayer’s consent to extend the
three-year limit to allow it more time to complete an audit
(Form SS-10).
Preparing for the Audit
 First, decide whether the audit will be handled by the
taxpayer or the taxpayer’s representative (Tax attorney,
CPA or both).
 Second, when and where will the audit take place
 Third, gather together all the payroll records pertaining to
the year or years being audited. This includes any
workpapers used in the preparation of the return.
Handling the Actual Audit
 As the audit progresses, the taxpayer should keep in mind
that the burden is on him to prove he has paid the proper
amount of tax.
 The auditor should be allowed to complete his audit before
there is any discussion of specific items.
 Cooperation with the agent will, in the typical case, bring
the audit to a speedy and satisfactory conclusion.
Trust Fund Recovery Penalty
 If the employer fails to withhold the proper amount of
FITW, he remains liable for the unpaid amount.
 An individual in the employing firm who is responsible for
the collection and payment of withholding taxes may be
held personally liable for a penalty of 100% of the unpaid
taxes if income taxes and social security taxes are not
withheld or if the withheld taxes are not paid to the IRS.
 In 1993, the IRS relaxed the definition of a responsible
person and strengthened the procedures that IRS agents
must follow before the penalty can be assessed.
“The material contained in this presentation is for general
information and should not be acted upon without prior
professional consultation.”