IRS to Expand Small Biz Audits

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BOSTON (TheStreet) -- The Internal Revenue Service, trying to recoup some of the estimated $14 billion that companies underpay in employer taxes a year, plans to wage a three-year campaign to audit 6,000 businesses.

The cash-strapped government, which separately said it wants to put a levy on large financial firms that received bailouts, will zero in on worker classification, fringe benefits, reimbursed expenses and executive compensation. The selection of the audited companies will be random, and both big and small businesses will be scrutinized.

Defining who is, or isn't, an employee may be the biggest challenge for the IRS and those it audits. While some businesses may be confused about how to properly classify workers, others may misclassify employees to bypass protections such as minimum-wage laws, child-labor standards and overtime requirements, and to avoid having to offer health and pension plans.

"If someone is classified as an independent contractor, they might not be included in a health plan or a 401(k) plan," says Shelly Youree, a senior partner with Thompson & Knight LLP who specializes in employee benefits and executive compensation. "But if they are reclassified by the IRS, the employee may be entitled to benefits retroactively."

The IRS last embarked on a comprehensive assessment of misclassification in 1984. At the time, the agency estimated that about 15% of employers misclassified 3.4 million workers. A 2005 government survey determined that 10.3 million U.S. workers were categorized as independent contractors, about 7.4% of the workforce.

"The matter of who is an employee versus an independent contractor is, in the tax world, almost akin to a religious concept," says GJ Stillson MacDonnell of the law firm Littler Mendelson and chair of its Employment Taxes Practice Group. "It is how you feel and what your faith in the concept is all about. It is difficult to nail down. There is no bright-line test."

Case in point: Shipping giant FedEx (Stock Quote: FDX) is in a legal battle with the IRS over an attempt to collect as much as $14 million in taxes and penalties following an audit over independent contractors.

The IRS audits may also have an effect on two hot-button issues: health care reform and executive compensation. The agency may be able to track, on behalf of the government, who has a right to be offered health insurance. And the IRS may be the conduit for a tax crackdown on such corporate largesse as golden parachutes and Goldman Sachs-style (Stock Quote: GS) bonuses.

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