4.23.5  Technical Guidelines for Employment Tax Issues (Cont. 1)

4.23.5.7 
Government Entities

4.23.5.7.3  (12-10-2013)
Public Retirement Systems

  1. A public retirement system is a pension, annuity, retirement, or similar fund or system established and maintained by a State or political subdivision (or an agency or instrumentality thereof) that provides retirement benefits to its employees that are comparable to the benefits provided under the Old-Age portion of the Old-Age Survivors and Disability Insurance (Social Security) part of FICA. See Treas. Regs. 31.3121(b)(7)-2 for further information on the requirements for a pubic retirement system.

  2. Social security is NOT a public retirement system for purpose of the definition in (1).

4.23.5.7.3.1  (08-31-2012)
Types of Retirement Systems

  1. In general, there are two types of retirement systems – the defined contribution plan and the defined benefit plan. The retirement system: .

    1. Provides retirement benefits to governmental employees who are participants, and

    2. May be a qualified plan described in IRC 401(a), an annuity plan or contract under IRC 403(a) or (b), or a nonqualified deferred compensation plan described in IRC 457(b), 457(f) or 409A.


    The minimum benefit requirements are contained in Treas. Regs. 31.3121(b)(7)-2(e)(2) and in Rev. Proc. 91-40, 1991-2 C.B. 694.

4.23.5.7.3.2  (11-03-2009)
Defined Contribution Plan

  1. A defined contribution plan is a plan that provides an individual account for each participant and provides benefits based solely on the amount contributed to the participant's account, and any income, expenses, gains or losses that may be allocated that participant's account. See IRC 414(i).

  2. A defined contribution plan that satisfies the definition of a IRC 3121(b)(7)(F) retirement system must provide for an allocation to the employee's account of at least 7.5 percent of the employee's compensation for service performed during the period under consideration.

  3. Contributions from both the employer and employee may be used to make up the 7.5 percent. Matching contributions by the employer may be taken into account for this purpose. However, the 7.5 percent cannot include any earnings on the account. See Treas. Reg. 31.3121(b)(7)-2(e)(2)(iii)(A).

  4. The defined contribution plan must credit the employees' accounts with a reasonable interest rate, or the accounts must be held in a separate trust subject to general fiduciary standards and credited with actual earnings on the trust fund. See Treas. Reg. 31.3121(b)(7)-2(e)(2)(iii)(C).

  5. An employee is a qualified participant in a defined contribution retirement system with respect to services performed on a given day if, on that day, the employee has satisfied all conditions (other than vesting) for receiving an allocation to his or her account (exclusive of earnings) that meets the minimum retirement benefit requirement. The benefit must be calculated with respect to compensation during a period ending on that day and beginning on or after the beginning of the plan year of the retirement system. This is the case regardless of whether the allocations were made or accrued before the effective date of IRC 3121(b)(7)(F). See Treas. Reg. 31.3121(b)(7)-2(d)(1)(ii).

  6. A part-time, seasonal, or temporary employee is not a qualified participant on a given day unless any benefit relied upon to meet the minimum benefit requirement is 100–percent non-forfeitable on that day. See Treas. Regs. 31.3121(b)(7)-2(d)(2).

4.23.5.7.3.3  (08-31-2012)
Defined Benefit Plan

  1. A defined benefit plan is any plan other than a defined contribution plan (IRC 414(j)). A defined benefit plan determines benefits on the basis of a formula, generally based on age, years of service, and compensation.

  2. A defined benefit plan must provide a retirement benefit comparable to the benefit provided by the social security part of FICA. A plan generally meets the requirement if the benefit under the system is at least 1.5 percent of average compensation during the employee's last three years of employment, multiplied by the employee's number of years of service.

  3. An employee is a qualified participant in a defined benefit retirement system with respect to services performed on a given day if, on that day, the employee is or has ever been an actual participant in the retirement system and the employee actually has a total accrued benefit that meets the minimum retirement benefit requirement. See Treas. Reg. 31.3121(b)(7)-2(d)(1)(i).

  4. An employee may not be treated as an actual participant or as actually having an accrued benefit for this purpose to the extent that such participation or benefit is subject to any conditions (other than vesting) that have not been satisfied. For example, such conditions include a requirement that the employee attain a minimum age, perform a minimum period of service, make an election in order to participate, or be present at the end of the plan year in order to be credited with an accrual. See Treas. Reg. 31.3121(b)(7)-2(d)(1)(i).

4.23.5.7.4  (02-01-2003)
Examination of State/Local Government Entities

  1. The Federal, State and Local Governments office (FSLG) has the primary responsibility for examination of state and local government entities.

  2. Any unusual issues or trends uncovered by other Operating Divisions should be referred to the Director of Federal, State and Local Governments. Additional procedures and guidelines for state and local government entities are outlined in IRM 4.90, Federal, State and Local Governments (FSLG).

4.23.5.7.5  (02-01-2003)
Federal Agencies

  1. Federal agencies are generally bound by the same statutory and common law rules as the private sector. The Federal, State and Local Governments office (FSLG) has overall responsibility for employment compliance efforts involving Federal agencies.

  2. There are unique protocol issues for Federal agencies, including the military. If a compliance issue or lead involving a federal agency is received by another IRS office, this lead or issue should be referred to the Federal, State and Local Governments Headquarters Office in Washington, D.C.

  3. Guidance has been provided to Federal employers by the Office of Personnel Management on the employer-employee relationship and the proper classification of workers.

4.23.5.7.5.1  (11-03-2009)
Examination of Federal Agencies

  1. The Federal, State and Local Governments office (FSLG) has primary responsibility for examination of employment tax returns filed by Federal agencies. Because Federal agency headquarters are in Washington, D.C., the Federal Agency Group will take the lead in identifying compliance issues and coordinating Federal agency examinations. IRM 4.90 provides additional guidance and information.

  2. If a potential employment examination issue for a Federal agency is uncovered, a referral must be made to the Office of Federal, State and Local Governments in TE/GE. Refer to IRM 4.90.6, Federal, State and Local Governments (FSLG) - Referrals, for additional guidelines on referrals to Federal State and Local Governments.

4.23.5.8  (02-01-2003)
Social Security Coverage of Employees of Nonprofit Organizations

  1. The Social Security Amendments of 1983 extended social security coverage on a mandatory basis to all employees of IRC 501(c)(3) organizations with respect to services performed on or after January 1, 1984. Terminations of coverage by organizations which had waived their exemptions under IRC 3121(k)(1)(D) would not be permitted on or after March 31, 1983.

4.23.5.9  (12-10-2013)
Social Security Coverage for Church Employees

  1. IRC 3121(w) provides that any church or qualified church-controlled organization may make an election within the time period described below, that services performed in the employ of such church or organization shall be excluded for purposes of Title II of the Social Security Act. An election may be made under this section only if the church or qualified church-controlled organization (see (4) below) states that such church or organization is opposed for religious reasons to the payment of the tax imposed under IRC 3111. The election is made on Form 8274, Certification By Churches and Qualified Church – Controlled Organizations Electing Exemption from Employer Social Security and Medicare Taxes.

  2. The election under IRC 3121(w) must be made prior to the first date on which a quarterly return is due or would be due had the election not been made. This election does not apply to services as ministers of a church, members of a religious order, or to services performed in an unrelated trade or business of the church or qualified church organizations. An election under this section applies to current and future employees. This election may be permanently revoked by the organization by paying Social Security and Medicare taxes for wages covered by this section. The Service will permanently revoke the election if the organization does not file Forms W-2 for two years or more and does not provide the information within 60 days after a written request by the Service.

  3. Although the employees of an electing church or organization are exempt from payment of FICA tax, these employees generally must pay social security tax under the rules that govern self-employed persons if they are paid $108.28 or more in a year. See IRC 1402(j)(2)(B) and Form 8274, Certification by Churches and Qualified Church-Controlled Organizations Electing Exemption from Employer Social Security and Medicare Taxes. The electing church or organization remains subject to the requirements for withholding and reporting of income tax on wages, tips and other compensation paid to each employee on Form W-2, Wage and Tax Statement.

  4. For purposes of this section, the term "church" means a church, a convention or association of churches, or an elementary or secondary school that is controlled, operated, or principally supported by a church, convention, or association of churches. The term "qualified church organization" is defined in IRC 3121(w)(3)(B).

  5. Where related entities are separate employers, an election must be made for each employer. In instances where there is doubt as to which church or organization is the employer of a particular worker, it is advisable for each to file a separate Form 8274. In order to elect the exemption, Form 8274 must be signed by an authorized official of the church or organization and filed with the IRS Campus where the church or organization would file its Form 941, Employer's Quarterly Federal Tax Return. The election exempts a church or organization and its employees from employer and employee FICA taxes and applies to all services performed on or after January 1, 1984, by employees of the electing church or organization, whether or not they were employees on January 1, 1984, or on the date the election is made. Employment Code "C" on IDRS indicates the organization has filed Form 8274.

4.23.5.10  (12-10-2013)
FICA Tax on Wages Paid to Residents of the Philippines for Services Performed in the Commonwealth of Northern Mariana Islands (CNMI)

  1. The purpose of this section is to provide administrative guidance to IRS employees assigned to conduct enforcement activities on businesses in the CNMI that employ residents of the Philippines.

  2. IRC 3121(b)(18), in combination with the Covenant to Establish a Commonwealth of the Northern Mariana Islands in Political Union with the United States, provides an exception from employment for purposes of the FICA tax for services performed by residents of the Philippines temporarily admitted to the CNMI on H-2 status under the United States Immigration and Nationality Act (INA).

  3. Prior to November 28, 2009, the CNMI had its own immigration laws with its own visa categories, and the INA did not apply in the CNMI. However, CNMI immigration laws provided a CNMI temporary work visa in the Commonwealth of Northern Mariana Code, which was similar to INA’s H-2 status. The IRS determined that the exemption from FICA under section 3121(b)(18) applied to residents of the Philippines admitted to the CNMI on this similar CNMI temporary work visa.

  4. On May 8, 2008, Congress enacted the Consolidated Natural Resources Act of 2008 (CNRA), which extended federal immigration laws of the INA to the CNMI. As a result, CNMI immigration laws no longer apply and CNMI visas and work permits no longer exist. Nonresident aliens in the CNMI must apply for a federal immigration status if they wish to remain in the CNMI.

  5. Residents of the Philippines employed in the CNMI are no longer exempt from FICA tax on the basis of holding a work permit under CNMI immigration law. While the CNMI is transitioning to full implementation of U.S. immigration law, a new Commonwealth Only Transitional Worker (CW) visa classification is available to workers in the CNMI. Workers on the CW visa, including those from the Philippines, are not exempt from FICA tax under IRC 3121(b)(18). Employers are required to withhold and pay FICA tax unless the worker in the CNMI is eligible for an exemption from FICA tax as a resident of the Philippines holding a valid U.S. H-2 visa or based on some other circumstance.

    Note:

    The FICA exemption applies to both the H-2A and H-2B visas held by non-immigrant Philippine residents whether they are Resident Aliens or Nonresident Aliens.

  6. Many residents of the Philippines currently employed in the CNMI have been seeking to determine their proper immigration status. As a result, these workers and their employers have been or are uncertain about their immigration statuses. For this reason, and in order to ease the CNMI’s transition to federal immigration law, Announcement 2012-43 provides that the IRS will not assert that any taxpayer has understated liability for FICA taxes by reason of a failure to treat services performed before January 1, 2015, in the CNMI by a resident of the Philippines as employment under IRC 3121(b) of the Code. Accordingly, IRS employees should cease enforcement activity regarding the imposition of FICA tax owed by businesses in the CNMI on wages paid to residents of the Philippines until after December 31, 2014. IRS employees should resume normal enforcement activity to ensure that employers in the CNMI withhold and pay FICA taxes on wages paid to residents of the Philippines who do not hold an H-2 status for services performed in the CNMI after December 31, 2014, unless those workers are eligible for FICA exemption based on some circumstances other than the exemption at IRC 3121(b)(18).

4.23.5.11  (08-31-2012)
Related Corporations Providing Concurrent Employment—Common Paymaster

  1. When an employee is concurrently employed by two or more related corporations and compensated through a common paymaster, the aggregate dollar amounts for FICA and FUTA taxes shall be no more than the taxes imposed upon a single employer. See IRC 3121(s) and IRC 3306(p).

  2. In these situations, the examiner should determine under the provisions of Treas. Regs. 31.3121(s)-1 that:

    1. The corporations are considered related under one of the four tests provided,

    2. The common paymaster is a member of the related group and the employees covered under these provisions do receive their remuneration through a common paymaster, and

    3. There is concurrent employment which contemplates the performance of services by the employee for the benefit of the employing corporations.

  3. The provisions of this section apply only to remuneration disbursed in the form of money, check or other similar instrument. Be alert to other forms of compensation subject to FICA and FUTA taxes.

  4. If the common paymaster fails to remit these taxes, it remains liable for the full amount of the unpaid portion of these taxes. In addition, each of the other related corporations using the common paymaster is jointly and severally liable for its appropriate share of these taxes. See Treas. Reg. 31.3121(s)-1(c)(1).

  5. The common paymaster is responsible for filing information and tax returns and issuing Form W–2 with respect to wages it paid under this section.

  6. Neither IRC 3121(s) or IRC 3306(p) have any effect on the deductibility for Federal income tax purposes of employment taxes or of wages payable by a corporation through a common paymaster. Each corporation is entitled to its own deduction.

4.23.5.11.1  (11-03-2009)
Wages Paid by Predecessor Attributed to Successor

  1. The successor may count the taxable wages paid by the predecessor to a continuing employee for purposes of the total wage limitations if:

    1. An employer during any calendar year acquires all or substantially all of the property used in the trade or business of a predecessor employer or a unit of the business of such employer,

    2. The employee was employed in the trade or business of the predecessor employer immediately prior to the acquisition and is employed by the successor employer in its trade or business immediately after the acquisition, and

    3. Such wages were paid during the calendar year in which the acquisition occurred and prior to such acquisition.

  2. The acquisition may also occur as a result of the incorporation of a business by a sole proprietor or a partnership. In addition, a previously existing partnership that is continued by a new partnership or by a sole proprietorship may allow the successor to count the taxable wages paid by the predecessor employer of a continuing employee.

4.23.5.12  (11-03-2009)
Fringe Benefits

  1. A fringe benefit is any cash, property, or service that an employee receives in addition to regular taxable wages. IRC 61 states that, except as otherwise provided, gross income means all income from whatever source derived, including but not limited to, compensation for services including fees, commissions, fringe benefits, and similar items. Consequently, a fringe benefit provided by an employer to an employee is presumed to be income to the employee unless it is specifically excluded from gross income by another section of the Code. See Treas. Regs.1.61-21(a).

  2. Publication 15–B, Employer's Tax Guide to Fringe Benefits, may be used for quick research on the treatment of certain fringe benefits. However, the Code, regulations, revenue rulings, and court decisions are the authority for any proposed issues.

  3. The following non-exhaustive list provides examples of fringe benefits:

    • Automobile allowances

    • Awards and prizes

    • Back pay awards

    • Bonuses

    • Cafeteria plans

    • Chauffeur services

    • Communications equipment (such as cell phones)

    • Company owned or leased aircraft

    • Company owned or leased vehicles

    • Country club memberships

    • Dependent care assistance programs

    • Disability payments

    • Discounts on property or services

    • Educational reimbursements

    • Executive dining rooms

    • Estate planning

    • Financial counseling

    • Free or subsidized lodging

    • Golden parachute payments

    • Group term life insurance

    • Home security systems

    • Income tax return preparation

    • Legal services

    • Loans (low interest or interest-free)

    • Low interest loans

    • Local transportation for commuting

    • Meals or meal money/allowances

    • Moving expense reimbursements

    • Outplacement services

    • Parking

    • Personal computers allowed to be used at home

    • Personal liability insurance

    • Physical examinations

    • Reimbursement of expenses on the sale of a personal residence

    • Safety awards

    • Severance pay

    • Scholarships and fellowships

    • Sick pay

    • Spousal travel

    • Stock options

    • Travel reimbursement

    • Use of vacation homes

    • Vacations (all expense paid or discounted)

4.23.5.12.1  (08-31-2012)
Statutory Exclusions from Gross Income

  1. After a fringe benefit is identified, it is necessary to determine whether there is a statutory provision that specifically excludes it from gross income. The Code excludes the following fringe benefits from income:

    1. Employee achievement awards (IRC 74(c))

    2. Group-term life insurance (IRC 79)

    3. Amounts received under accident or health plans ( IRC 105)

    4. Contributions by an employer to an accident or health plan (IRC 106)

    5. Rental value of parsonages (IRC 107)

    6. Certain combat pay of members of the armed forces (IRC 112)

    7. Qualified tuition reduction (IRC 117(d))

    8. Meals or lodging furnished for the convenience of the employer (IRC 119)

    9. Cafeteria plans (IRC 125)

    10. Educational assistance program (IRC 127)

    11. Dependent care assistance (IRC 129)

    12. Certain fringe benefits (IRC 132)

    13. Certain qualified military benefits (IRC 134)

  2. For a statutory exclusion to apply to an identified fringe benefit, the requirements of the Code section must be met. Even if an exclusion applies, the result may be that the value of the fringe benefit is only partially excludable from the employee’s wages.

4.23.5.12.2  (08-31-2012)
Fringe Benefits under IRC Section 132 and Definitions

  1. IRC 132(a) provides that gross income shall not include any fringe benefit that qualifies as one of the following:

    1. No-additional-cost service,

    2. Qualified employee discount,

    3. Working condition fringe,

    4. De minimis fringe,

    5. Qualified transportation fringe,

    6. Qualified moving expense reimbursement,

    7. Qualified retirement planning services, or

    8. Qualified military base realignment and closure fringe.

  2. No–Additional–Cost Services:IRC 132(b) applies when an employee receives a free or reduced charge service at no substantial additional cost to the employer. Generally, no–additional–cost services are only available to employees with respect to services that are offered for sale to customers in the ordinary course of the same line of business in which the employee performs substantial services for the employer. Generally, no–additional–cost services are excess capacity services, such as airline tickets or hotel rooms.

  3. Qualified Employee Discount:IRC 132(c) applies to a price reduction an employer gives an employee on qualified property or services that are offered to customers in the ordinary course of the same line of business in which the employee performs substantial services for the employer. The discount on services is limited to 20% of the price charged to customers. The discount on merchandise cannot exceed the gross profit percentage times the price charged to customers for the item.

  4. Working Condition Fringe:IRC 132(d) applies to any property or service provided to an employee to the extent that, if the employee paid for it, the amount paid would be allowable as a deduction as an ordinary and necessary business expense under IRC 162 or IRC 167. This exclusion applies to property and services provided by an employer to an employee, necessary for an employee to perform their job. Examples of working condition fringe benefits include an employee's use of a company car for business or the provision of job-related education.

  5. De minimis Fringe:IRC 132(e) applies to any property or service provided to employees that is provided infrequently and has so little value that accounting for it would be unreasonable or administratively impracticable. A cash fringe benefit (or cash equivalent) is never excludable as de minimis, regardless of amount, except for occasional meal money or transportation fare meeting certain conditions. Examples of de minimis fringe benefits include:

    1. Occasional personal use of a company copying machine,

    2. Occasional parties or picnics for employees and their guests,

    3. Occasional tickets for entertainment or sporting events,

    4. Flowers or fruit for special occasions, and

    5. Holiday gifts, other than cash, with a low fair market value.

  6. Qualified Transportation Fringes: This exclusion is defined in IRC 132(f) and applies to the following benefits:

    1. A ride in a commuter highway vehicle, under IRC 132(f)(5)(A), meaning any highway vehicle that transports the employee between the employee's home and work place. The vehicle must seat at least 6 adults (excluding the driver) and the expectation must exist that at least 80% of the vehicle's mileage will be for transporting employees between home and work. Employees must occupy at least one-half of the seats, not including the driver.

    2. A transit pass, under IRC 132(f)(5)(A), meaning any mass transit pass, token, farecard, or voucher entitling a person to ride free or at a reduced rate on a mass transit system or in a commuter highway vehicle as defined previously.

    3. Qualified parking, under IRC 132(f)(5)(C), meaning parking that the employer provides to employees on or near the employer's business premises. It also includes parking on or near the location from which employees commute to work using mass transit, commuter highway vehicles, carpools or any other means.

  7. Qualified Moving Expense Reimbursement:IRC 132(g) applies to any amount given to an employee, directly or indirectly, as payment for, or a reimbursement of, moving expenses. Only those expenses that the employee could deduct under IRC 217, if the employee had paid or incurred them, are excludable. Any other expenses paid by the employer on behalf of the employee are includible as compensation subject to employment taxes. Examples of non-excludable expenses include house-hunting trips, storage of goods, closing costs, and interest free or low interest loans when an employee's former home has not sold. Expenses that qualify under this exclusion are limited to reasonable expenses for:

    1. Moving household goods and personal effects from the former home to the new home, and

    2. Traveling expenses, including lodging, from the former home to the new home.

  8. Qualified Retirement Planning Services:IRC 132(m) applies to any retirement planning advice or information provided to an employee and the employee's spouse by an employer maintaining a qualified employer plan. A qualified plan includes an employer's pension, profit-sharing, or stock bonus plan. It also includes an annuity plan described in IRC 403(a) or IRC 403(b), a simplified employee pension within the meaning of IRC 408(k) and any simple retirement account described in IRC 408(p).

  9. Qualified Military Base Realignment and Closures:IRC 132(n) applies to certain payments to offset the adverse effects on housing values as a result of a military base realignment or closure.

  10. On-Premises Athletic Facilities:IRC 132(j)(4)(B) means an on–premises athletic facility operated by the employer substantially all of the use is by employees, their spouses, and their dependent children. The athletic facility must be located on premises that the employer owns or leases. A public facility or a facility for residential use does not qualify for this exclusion. See IRC 132(j)(4).

4.23.5.12.3  (02-01-2003)
Valuation of Fringe Benefits

  1. A non–cash fringe benefit is typically valued at its fair market value. This is the amount an employee would have to pay a third party in an arm's–length transaction to buy or lease the benefit. See Treas. Reg. 1.61-21(b).

  2. The Regulations provide special valuation rules for some commonly provided fringe benefits such as automobile and airplane travel.

4.23.5.12.3.1  (08-31-2012)
Employer Provided Cell Phones

  1. For taxable years after December 31, 2009, cell phones were removed from the definition of listed property by Section 2043 of the Small Business Jobs Act of 2010. The Act did not otherwise alter the requirement that an employer-provided cell phone was a fringe benefit, the value of which must be included in the employee's gross income unless an exclusion applies.

  2. Notice 2011-72, issued September 14, 2011, provides guidance on the treatment of employer-provided cell phones or other similar telecommunications equipment (collectively "cell phones" ).

  3. The notice provides that, when an employer provides an employee with a cell phone primarily for noncompensatory business reasons, the IRS will treat the employee’s use of the cell phone for reasons related to the employer’s trade or business as a working condition fringe benefit. The value of this use will be considered excludable from the employee’s income and, solely for purposes of determining whether the working condition fringe benefit provision in IRC 132(d) applies, the substantiation requirements that the employee would normally have to meet in order for a deduction to be allowable under IRC 162 are deemed to be satisfied.

  4. In addition, the IRS will treat the value of any personal use of a cell phone provided by the employer primarily for noncompensatory business purposes as excludable from the employee’s income as a de minimis fringe benefit.

  5. The application of the working condition and de minimis fringe benefit exclusions under the notice apply solely to employer-provided cell phones and should not be interpreted as applying to any other fringe benefits.

  6. Tablet devices, such as iPads, are considered "similar telecommunications equipment."

  7. The rules of the notice apply to any use of an employer-provided cell phone occurring after December 31, 2009.

4.23.5.12.3.2  (08-31-2012)
Employer Payments for Employee Cell Phones

  1. Concurrently with the issuance of Notice 2011-72 on employer-provided cell phones, Interim Guidance Memorandum SBSE-04-0911-083, "Interim Guidance on Reimbursement of Employee Personal Cell Phone Usage in light of Notice 2011-72," was issued. The purpose of this memorandum is to provide audit guidance to examiners regarding employers that reimburse their employees for the business use of an employee’s personal cell phone. The document is not intended to be a technical position, but to provide guidance to examiners who encounter this issue.

  2. In cases where employers, for substantial non-compensatory business reasons, require employees to maintain and use their personal cell phones for business purposes and reimburse the employees for the business use of their personal cell phones, examiners should analyze reimbursements of employees’ cell phone expenses in a manner that is similar to the approach described in Notice 2011-72.

  3. Specifically, in cases where employers have substantial business reasons, other than providing compensation to the employees, for requiring the employees’ use of personal cell phones in connection with the employer’s trade or business and reimbursing them for their use, examiners should not necessarily assert that the employer’s reimbursement of expenses incurred by employees after December 31, 2009, results in additional income or wages to the employee. Conditions include that:

    • The employee must maintain the type of cell phone coverage that is reasonably related to the needs of the employer’s business,

    • The reimbursement must be reasonably calculated so as not to exceed expenses the employee actually incurred in maintaining the cell phone, and

    • The reimbursement for business use of the employee’s personal cell phone must not be a substitute for a portion of the employee’s regular wages.

  4. Arrangements that replace a portion of an employee’s previous wages with a reimbursement for business use of the employee’s personal cell phone and arrangements that allow for the reimbursement of unusual or excessive expenses should be examined closely.

  5. Examples of substantial non-compensatory business reasons for requiring employees to maintain personal cell phones and reimbursing them for their use include:

    • The employer’s need to contact the employee at all times for work-related emergencies, and

    • The employer’s requirement that the employee be available to speak with clients at times when the employee is away from the office or at times outside the employee’s normal work schedule (i.e., clients are in different time zones).

  6. An example of a reimbursement arrangement that does not result in additional income or wages is as follows:

    An employer has a substantial non-compensatory business reason for requiring the employee to maintain a personal cell phone to facilitate communication with the employer's clients during hours outside the employee's normal tour of duty in the office and reimbursing the employee for the use of the phone. The employee uses the cell phone for both business purposes and personal purposes and the employee’s basic coverage plan charges a flat-rate per month for a certain number of minutes for domestic calls. The employer reimburses the employee for the monthly basic plan expense to enable the employee to maintain contact with business clients throughout the United States after hours.

  7. Examples of reimbursement arrangements that may be in excess of the expenses reasonably related to the needs of the employer’s business and should be examined more closely include:

    1. Reimbursement for international or satellite cell phone coverage to a service technician whose business clients and other business contacts are all in the local geographic area where the technician works, or

    2. A pattern of reimbursements that deviates significantly from a normal course of cell phone use in the employer’s business (i.e., an employee received reimbursements for cell phone use of $100/quarter in quarters 1 through 3, but receives a reimbursement of $500 in quarter 4).

4.23.5.12.4  (11-03-2009)
Audit Techniques for Identifying Fringe Benefits

  1. Fringe benefits can be a significant form of compensation, and examiners should consider fringe benefit issues during an examination. Fringe benefits can be identified from a number of sources. Examiners should inspect the following documents and records, if available:

    1. Employee benefits handbook,

    2. Union agreements,

    3. Employment contracts (particularly those for executives),

    4. Annual financial reports,

    5. SEC reports such as Form 10-K and proxy statements,

    6. Taxpayer's web site,

    7. Corporate minutes,

    8. Chart of accounts,

    9. Written policies and procedures regarding fringe benefits,

    10. Accounts payable journal,

    11. Schedule M-1 or M-3 workpapers,

    12. General ledger accounts that include employee benefits, and

    13. Payroll journals.

  2. Examiners should also look at expense categories that are less obvious but may include fringe benefits such as miscellaneous expenses, meetings, automobile expense, insurance, and travel expense reimbursements.

  3. When discussing fringe benefits with the taxpayer, it is important that examiners communicate with the appropriate parties. For example, personnel in the payroll department may not have the same awareness of benefits as those in the human resources department. Discussions with other team members are also important because they may encounter potential employment tax issues in the course of their examinations.

4.23.5.12.5  (08-31-2012)
Reporting Fringe Benefits

  1. Non-cash fringe benefits are includible in the employee's wages in either the pay period, the quarter or any other period the employer chooses, as long as the fringe benefits are treated as paid at least once per calendar year. Employers do not have to make the same election for all employees and may change their election as frequently as they desire. Employers may treat the value of non-cash fringe benefits provided during the last two months of the calendar year or any shorter period as paid during the subsequent calendar year.

  2. Fringe benefits are subject to all employment taxes including social security, Medicare, FUTA, and income tax withholding unless special rules apply.

4.23.5.13  (08-31-2012)
Executive Compensation

  1. LB&I employment tax cases may include issues that are generally associated with executives and other highly compensated employees. Because of restrictions on qualified retirement plans, particularly discrimination restrictions, more top paid employees are relying on nonqualified plans, as well as stock–based compensation and golden parachute arrangements, to insure job security and provide additional retirement benefits.

  2. LB&I implemented the Corporate Executive Compliance Strategy (CEC) to support the Service-wide goal of improving compliance of high income taxpayers. The CEC focuses on executive compensation issues as well as tax shelter issues and non-filing by executives. Examiners are required to assess the compliance risk of corporate officers and other key executives as part of any LB&I examination. IRM 4.46.3.5.7, Corporate Officers’ Returns, discusses the requirements to verify fact of filing and to inspect certain executives’ tax returns. Additional guidance on inspection of officers’ returns has been published in Q. & A. format at the following web site: http://lmsb.irs.gov/hq/fs/employment_tax/ASPVersion/Resources_and_Information/CEC/CEC_FAQ.asp
    Audit technique guides and other audit tools related to executive compensation issues are posted under "Resources and Information" at the LB&I Employment Tax web site at:http://lmsb.irs.gov/hq/fs/employment_tax/index.asp

4.23.5.13.1  (08-31-2012)
Nonqualified Deferred Compensation

  1. A nonqualified deferred compensation (NQDC) plan is an elective or non-elective arrangement between an employer and an employee to pay the employee compensation some time in the future. NQDC plans differ from qualified plans in that they do not meet all of the requirements of IRC 401(a). The terms of these arrangements differ widely, but their common objective is to provide tax deferral for a specified period. NQDC plans may provide for payment upon retirement, death, disability or termination of employment. Others may permit payment after a specified number of years.

  2. In contrast to the general timing rule under which remuneration is subject to FICA tax when "actually or constructively paid" (Treas. Reg. 31.3121(a)-2(a)), amounts deferred under a NQDC plan are subject to FICA tax at the later of:

    1. When the services are completed, or

    2. When there is no substantial risk of forfeiture.

    This is referred to as the "special timing rule." NQDC is taxed (taken into account) only once. When amounts are paid from the plan in a later period, they are not subject to additional FICA and FUTA taxes provided the amounts were properly taken into account at the time of deferral. In addition, any earnings attributed to the amounts deferred are likewise not subject to FICA or FUTA. This rule is commonly called the "nonduplication rule." See Treas. Reg. 31.3121(v)(2)-1(a)(2)(iii).

  3. Participants in NQDC plans may include the following individuals:

    • Key executives and/or directors,

    • A select group of management or highly compensated employees,

    • Employees whose benefits are limited by qualified plan rules, or

    • Any other employee whom the employer wishes to reward.

  4. The most commonly used types of NQDC plans are salary reduction arrangements, bonus deferral plans, top-hat plans, and excess benefit plans.

    • Salary reduction arrangements: This type of plan simply defers the receipt of otherwise currently taxable compensation by allowing the executive to select a percentage or dollar amount to be taken out of current salary and have the employer pay the deferred amount at a future date.

    • Bonus deferral plans: This is similar to a salary reduction arrangement, except that it defers receipt of an employee’s bonus.

    • Top-hat plans: Also known as Supplemental Executive Retirement Plan (SERP). These are NQDC plans primarily for a select group of management or highly compensated employees to supplement qualified retirement plans.

    • Excess benefit plans: Also known as benefit equalization plans or benefit replacement plans. These are NQDC plans that provide benefits to employees whose benefits under the employer’s qualified plan are limited by IRC 415.

  5. All NQDC plans are either unfunded or funded. Most NQDC plans are intended to be unfunded arrangements because of the tax advantages.

  6. With an unfunded arrangement, the employee has only the employer’s "mere promise to pay" the deferred compensation in the future and the promise is not secured in any way. The employer may simply keep track of the benefit in a bookkeeping account or may invest the funds in annuities, securities, or insurance arrangements. In order to help fulfill its mere promise to pay the employee, the employer may transfer funds to a trust that remains a part of the employer’s general assets, subject to the claims of the employer’s creditors upon insolvency.

  7. Generally, a funded arrangement exists if assets are set aside from the claims of the employer’s creditors, for examples, in a trust, escrow, or annuity.

4.23.5.13.1.1  (08-31-2012)
Section 409A

  1. If a deferred compensation plan does not comply with IRC 409A, all amounts deferred under the plan for all taxable years are currently includible in gross income to the extent not subject to a substantial risk of forfeiture and not previously included in gross income. Such amounts are also subject to two additional taxes, as discussed below.

  2. In general terms, IRC 409A imposes four principal requirements:

    • If a taxpayer is given an election to defer compensation, the election must be made not later than the time specified in the statute and regulations.

    • A taxpayer can elect to delay the payment date of deferred compensation (a subsequent or second election), but only if the election is made not later than a specified time.

    • Nonqualified deferred compensation (NQDC) can be paid only upon the occurrence of a specified trigger; (death, disability, change of control, separation from service, unforeseeable emergency, or at a specified time or on a fixed payment schedule), and

    • Payment of nonqualified deferred compensation cannot b accelerated except as permitted in the regulations.

  3. In addition, IRC 409A limits an executive's ability to access untaxed deferred amounts and effectively precludes taxpayers from using offshore trusts to fund future payments and arrangements that trigger funding if the employer's financial health declines. IRC 409A also effectively stops employers from contributing funds to rabbi trusts for top executives if the employer has an underfunded qualified pension plan.

  4. NQDC plans subject to IRC 409A must comply with IRC 409A in both operation and in form. Generally, if an employee has deferred compensation under a plan that fails to comply with the IRC 409A operation requirements after December 31, 2008, the employee will have to pay regular income tax on the amounts deferred plus an additional 20% income tax on the amount, and a second additional income tax based on the underpayment interest (computed at the underpayment interest rate plus 1%) that would have been due if the amounts deferred had been includible in the employee's income in the year when the amounts were first deferred or, if later, vested.

  5. IRC 409A applies to amounts deferred after December 31, 2004 (including amounts deferred before that date that were not earned and vested before January 1, 2005). IRC 409A also applies to deferred amounts that were earned and vested before January 1, 2005 (grandfathered amounts) if the arrangement is materially modified after October 3, 2004.

  6. Beginning with Notice 2005-1, the Treasury Department and IRS published extensive guidance on IRC 409A including both transition relief and substantive requirements. The transition relief provided to taxpayers expired on December 31, 2008. In reverse chronological order, the guidance is as follows:

    • Notice 2010-80, modification to the relief and guidance on corrections of certain failures of a NQDC plan to comply with IRC 409A,

    • Rev. Rul. 2010-27, guidance on what constitutes an unforeseeable emergency under IRC 457(b) and IRC 409A,

    • Notice 2010-6, relief and guidance on corrections of certain failures of a NQDC plan to comply with IRC 409A,

    • Notice 2009-92, guidance on the application of IRC 409A(a) to changes to NQDC plans to comply with an Advisory Opinion of the Office of the Special Master for TARP Executive Compensation

    • Notice 2009-49, guidance under IRC 409A(a)(2)(A)(v) on certain transactions pursuant to the Emergency Economic Stabilization Act of 2008

    • Notice 2008-113, relief and guidance on corrections of certain failures of a NQDC plan to comply with IRC 409A(a) in operation

    • Proposed Regulations 1.409A-4

    • Notice 2007-100, transition relief and guidance on corrections of certain failures of a NQDC plan to comply with IRC 409A(a) in operation

    • Notice 2007-86, notice of additional 2008 transition relief under IRC 409A

    • Notice 2007-78, transition relief and additional guidance on the application of IRC 409A to NQDC plans

    • Final Treas. Regs. 1.409A

    • Notice 2007-34, guidance regarding the application of IRC 409A to split-dollar life insurance arrangements

    • Announcement 2007-18, announcement establishing a compliance resolution program

    • Notice 2006-79, interim guidance

    • Notice 2006-64, interim guidance on the application of IRC 409A to accelerated payments to satisfy Federal conflict of interest requirements

    • Notice 2006-33, interim guidance on IRC 409A(b) regarding the use of an offshore rabbi trust

    • Notice 2006-4, interim guidance on the application of IRC 409A to stock rights issued by non-public companies

    • Proposed Regulations

    • Notice 2005-1, initial transactional guidance, relief, and reasonable good faith interpretation of the statute standard pending further guidance

4.23.5.13.2  (08-31-2012)
Stock-Based Compensation

  1. Stock in the employer's company is a commonly used form of compensation for employees and may also be provided as compensation for service providers who are not employees, such as outside directors. Stock–based compensation includes any compensation paid to an employee or independent contractor, either in cash or property, that is based on the value of the stock. This includes stock options, restricted stock awards, stock appreciation rights and phantom stock.

  2. A stock option is the right to purchase a given number of shares of stock at a given price within a specified period of time. Stock options granted in connection with the performance of services are either statutory or nonstatutory stock options. Statutory options include incentive stock options under IRC 422 and options issued under an employee stock purchase plan under IRC 423. All other options are nonstatutory options governed by IRC 83 and Treas. Reg. 1.83-7.

  3. Nonstatutory Stock Options: Any option that does not qualify for treatment as a statutory option is a nonstatutory option. Most nonstatutory stock options are taxed on the date of exercise or other disposition. The amount includible in income is the difference between the fair market value of the stock on the exercise date over the amount paid (spread amount). If an option is sold or otherwise disposed of prior to exercise, the money or property received is includible in income. The income is characterized as compensation income to the recipient for the year in which the option is exercised or the option is sold or otherwise disposed of prior to exercise.

    1. In the case of an employee, the amount includible in income under IRC 83 with respect to nonstatutory stock options is also subject to FICA, FUTA, and income tax withholding and must be reported on Form W-2. Non-employees, such as directors or outside contractors, are issued a Form 1099-MISC.

    2. A corresponding compensation expense deduction is generally allowed to the employer for the taxable year in which the optionee's taxable year of inclusion ends. See IRC 83(h) and Income Tax Regulations 1.83–6(a)(1) and the exception provided to this general rule in Treas. Reg. 1.83–6(a)(3). This expense generally is identified on the corporate income tax return as a Schedule M-1 adjustment under "Deductions on this return not charged against book income" or on Schedule M-3, Part III, Line 9, as a stock option expense.

  4. Statutory Stock Options: While nonstatutory stock options may be provided to any service provider, statutory options may be granted only to employees. IRC 421 to IRC 424 contain a set of requirements, all of which must be followed, for an option to be considered statutory. Violating any of these rules results in the option being disqualified. The result of disqualification is that the option is considered to be a nonstatutory option that is taxable under the rules of IRC 83. Statutory options include incentive stock options and options granted under an employee stock purchase plan.

  5. Incentive Stock Options: Incentive stock options (ISOs) are governed by IRC 422 and are not subject to the anti-discrimination rules. Although there are no anti-discrimination rules, there are still some rules addressing ISOs given to stockholders with a certain ownership percentage. The options can never be granted with an exercise price that is less than the FMV of the underlying stock on the date of grant. Gain from the sale of the stock purchased under the ISO is includible in gross income of the employee only upon sale or other disposition of the stock.

  6. Employee Stock Purchase Plans: Employee stock purchase plans (ESPPs) are governed by IRC 423 and are intended for all employees, with certain exceptions. See IRC 423(b)(4) for employees that may be excluded. All employees must be given an opportunity to participate in the plan without discrimination, with exceptions for new, part-time, seasonal, or highly compensated employees. The option to purchase stock can be price discounted but cannot be less than the lesser of 85% of the FMV of the stock on the date of grant or 85% of the value of stock on the date of exercise.

    Note:

    Unlike non-statutory stock options, compensation income is not recognized on the exercise of a statutory stock option unless there is a "disqualifying disposition."

  7. Disqualifying dispositions, under IRC 421(b), occur when stock acquired under a statutory stock option plan is sold or otherwise disposed of prior to the expiration of the applicable holding period. This is generally either two years after the date the option is granted or one year after the date the option is exercised. The income realized on the disqualifying disposition is treated as compensation to the extent of the spread amount (or gain if less). This compensation is included in the employee's Form W-2, but is not subject to FICA, FUTA, or income tax withholding.

  8. The exercise and qualifying disposition of stock acquired pursuant to a statutory stock option plan provide no tax deduction for the employer. See IRC 421(a)(2). However, the employer is entitled to a deduction for the amount the employee recognizes as compensation on a disqualifying disposition. See IRC 421(b).

  9. IRC 3121(a), IRC 3306(b), IRC 421(b) and IRC 423(c) were amended by the American Jobs Creation Act (AJCA) of 2004 to address the application of FICA and FUTA taxes and income tax withholding to statutory stock options. See IRC 3121(a)(22) and IRC 3306(b)(19). These sections provide that any exercise of a statutory stock option or disposition of stock acquired pursuant to such exercise will not result in wages for purposes of FICA and FUTA. Furthermore, income tax withholding will not apply to a disqualifying disposition or with respect to the ordinary income recognized upon a qualifying disposition of stock acquired pursuant to an employee stock purchase plan. These amendments are effective for exercises of statutory stock options exercised after October 22, 2004.

  10. Prior to the AJCA amendments, the position of the Service was set forth in Notice 2001-14 and Notice 2002-47. Notice 2001-14 placed a retroactive moratorium on any assessments until January 1, 2003. The notice provides that the Service will not enforce application of FICA and FUTA taxes upon the exercise of statutory stock options and will not enforce the application of income tax withholding upon the sale or disposition of stock acquired pursuant to such options. Notice 2002-47 effectively extended the moratorium.

  11. IRC 162(m) provides a $1 million deductible compensation limit for the CEO and four other highest compensated officers in a publicly traded corporation. However, see Notice 2007-49. Treas. Reg. 1.162-27(e)(2)(vi) provides a "qualified performance- based compensation" exception to the $1 million deduction limit for compensation attributable to option exercises if the option exercise price equals or exceeds the FMV on the grant date and certain other requirements are met. A failure to satisfy this requirement means that the option would fail to qualify for this particular exception, which will result in this compensation being subject to the $1 million deduction limit. An option exercise price backdated to a lower per-share cost based on a share value earlier in time would have an exercise price below the share value on the grant date, so that the executive would have a "built-in" profit on the option. This option would meet the "qualified performance based compensation" exception. As a result, compensation attributable to the option exercise would not be excludable from the calculation of the $1 million deduction limit as performance based compensation. See Treas. Reg. 1.162-27(e)(2)(vii), Example 9.

  12. Stock option plans are identified in a corporation's annual reports and also in reports filed with the SEC, such as Form 10-K and proxy statements. Examiners should inspect the Schedule M-1 or M-3 adjustments on the employer's income tax returns. Any income tax expense deductions taken in regard to stock-based compensation may appear as a deduction on the return that was not taken for book purposes.

4.23.5.13.3  (08-31-2012)
Golden Parachute Payments

  1. A corporation may have contracts with key personnel that provide for payments to be made if an executive loses his or her job as a result of a change in ownership or control of the company. These payments are referred to as "golden parachute payments."

  2. Tax laws were enacted that impact both payors and recipients who enter into or amend contracts after June 14, 1984. IRC 280G applies to the payor and disallows the deduction of an "excess parachute payment." IRC 4999 applies to the recipient and imposes a 20 percent nondeductible excise tax on any such payment. The excise tax must be withheld by the corporation. This excise tax is administered as an income tax under IRC 4999(c)(2). In addition, wages paid under golden parachute contracts are subject to FICA, FUTA, and income tax withholding, the same as other termination payments.

  3. A payment is generally considered an excess parachute payment if its present value, along with the present values of all such payments, equals or exceeds three times the average annual compensation of the recipient over the previous 5-year period. The amount of the payment over the average annual compensation is the excess parachute payment.

    Example:

    An officer of a corporation receives a golden parachute payment of $400,000. The officer′s average compensation over the previous 5–year period was $100,000. The excess parachute payment is $300,000 ($400,000 minus $100,000). The corporation cannot deduct the $300,000 and must withhold excise tax of $60,000 (20% of $300,000) from the payment.

  4. Payments under IRC 280G(b)(6), (payments pursuant to a qualified retirement plan), or IRC 280G(b)(4), (payments that the taxpayer establishes are reasonable compensation for services rendered on or after the date of change in control), are not considered parachute payments. In addition, parachute payments do not include payments made by a small business corporation or a corporation with no readily tradable stock if certain shareholder approval requirements are satisfied. See IRC 280G(b)(5).

  5. Golden parachute payments made to employees are reported on Form W–2 along with any taxes withheld. The total payment is included in Boxes 1, 3, and 5 and is subject to the usual income tax withholding, social security and Medicare taxes. The 20% excise tax on excess parachute payments is included in Box 2 as income tax withheld and is also reported in Box 12 with Code "K" . The employee must include the 20% excise tax in total taxes on Form 1040.

  6. Total golden parachute payments made to nonemployees are reported on Form 1099–MISC in Box 7, "Nonemployee Compensation." Any excess parachute payments are reported in Box 13, "Excess Golden Parachute Payments."

  7. To identify parachute payments, determine if a change in ownership or control has occurred. Changes in ownership or control may be determined by analyzing merger agreements, employment contracts, stock option plans, and deferred compensation plans. If a payment under certain benefit plans is accelerated, it may possibly be considered to be contingent on a change in ownership.

  8. Audit adjustments are made using the standard employment tax audit report forms. For employee adjustments, the 20% excise tax is computed on Page 2, Form 4668 - Schedule of Adjustments, line 14, "Other income tax withholding wage adjustment" of Form 4668, Employment Tax Examination Changes Report.

  9. For non-employee adjustments, the 20% excise tax is computed on lines 1 through 5 under the "Summary of Changes to Federal Income Tax Withholding" on Form 4668-B, Report of Examination of Withheld Federal Income Tax. Instructions for Line 1:

    • (a) "Excess Parachute Payment"

    • (b) "IRC 4999"

    • (c) "20%"

    • (d) Enter the amount of payment subject to the excise tax

    • (e) Computed excise tax (20% of (d))

4.23.5.14  (08-31-2012)
Excess Per Diem Payments under Revenue Ruling 2006-56

  1. Rev. Rul. 2006-56 provides guidance as to the proper employment tax treatment of expense allowance payments where an employer fails to treat amounts exceeding the federal per diem rate as wages.

  2. The revenue ruling holds that an expense allowance arrangement that:

    • Has no mechanism or process to determine when an allowance exceeds the amount that may be deemed substantiated,

    • Routinely pays allowances in excess of the amount that may be deemed substantiated without requiring actual substantiation of all expenses,

    • Requires no repayment of the excess of amount, and

    • Fails to treat the excess allowances as wages for employment tax purposes,

    is evidence of a pattern of abuse of the accountable plan rules. This abuse causes all payments made under the arrangement to be treated as paid under a nonaccountable plan.

  3. The revenue ruling was effective immediately upon issuance on November 9, 2006.

4.23.5.14.1  (08-31-2012)
Transition Rules for Revenue Ruling 2006-56 for Periods Prior to December 31, 2006

  1. As most taxpayers who were not in compliance with the new ruling may need time to update or secure accounting software to properly compute the amount of additional wages, transitional rules were put in place for taxable periods ending on or before December 31, 2006.

  2. For periods prior to December 31, 2006, absent egregious circumstances or evidence of intentional noncompliance, an examiner should not treat a plan as entirely nonaccountable solely because excess per diem payments were not treated as wages. Instead, the examiner should only treat the excess amounts over the federal per diem limit as wages.

4.23.5.14.2  (08-31-2012)
Considerations for Periods After December 31, 2006

  1. For periods after December 31, 2006, the examiner will determine whether the plan is abusive based on the extent of the excess payments that are not treated as wages and on whether a system for tracing excess payments is being utilized.

  2. There are four considerations to be addressed:

    1. When does an employer routinely make payments in excess of the deemed substantiated amount? The examiner should apply the following criteria:
      ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡

      Exception:

      ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡

      If the criteria is not met, excess payments will not constitute a pattern of abuse, absent other significant plan defects.

    2. When does an employer fail to track excess allowances? If the criteria above are satisfied, the agent must determine whether the employer has implemented and utilizes a system to track allowances that permits it to determine when the allowances paid, computed on a per diem basis, exceed the deemed substantiated amount and to treat such amounts as wages. If the agent determines the employer utilizes such a system, then the fact that the employer, due to errors in its system, routinely pays excess allowances that it does not treat as wages generally does not, on its own, evidence a pattern of abuse. Each case stands on its own, and a determination must be made based on the "facts and circumstances" of that particular case.

    3. What happens if a plan evidences a pattern of abuse? If a plan evidences a pattern of abuse, all of the per diem payments made under the plan will be treated as taxable wages.

    4. What happens if a plan does not evidence a pattern of abuse? If a plan does not evidence a pattern of abuse, but an employer has paid excess allowances without treating such amounts as wages, only the excess per diem payments will be considered taxable wages in the audit.

4.23.5.15  (08-31-2012)
Accountable Plans – Tool Reimbursements and "Rental" Payments

  1. Examiners may encounter employers who treat part of an employee’s compensation as "tool rental" or "tool reimbursement." They usually exclude these payments from wages. They may also report the payments on Form 1099-MISC as rental payments. These types of payments are no different from any other expense reimbursements and must meet the requirements of an accountable plan to be excluded from wages.

  2. Payments to employees for equipment they are required to provide as a condition of employment are wages for employment tax purposes unless paid under an accountable plan. See Rev. Rul. 2002-35.

  3. An employer who designates part of an employee’s compensation as a "tool allowance" must meet accountable plan requirements. To be excluded from wages, amounts paid to employees to cover expenses incurred to acquire or maintain tools must be paid under a reimbursement or other expense allowance arrangement that meets the requirements of IRC 62(c). An arrangement that provides for a tool allowance based upon hours worked or any other estimate fails to meet both the substantiation and the return of excess requirements and thus does not qualify as an accountable plan. See Rev. Rul. 2005-52.

  4. A related issue is the payment of "rent" to employees for the use of tools and equipment provided by the employees as a requirement of the job. These payments are usually reported to the employees on Forms 1099. This may be an attempt by the employer to circumvent the accountable plan rules. Generally, payments to employees for the use of employee-provided equipment are wages and not rent since the payments are related to the services provided as an employee and are not paid under an accountable plan. Thus, the payments should be considered wages subject to employment taxes and reportable on Form W-2 and Form 1040 unless the payments were made under an accountable plan.

  5. Typically, the employer will characterize a portion of each employee’s compensation as a reimbursement for equipment rather than as wages, thus avoiding both employment and income taxes on the equipment payment amount.

  6. Although the payment may be intended to reimburse the employee for the expenses incurred in purchasing and maintaining equipment, the amount is generally determined without reference to the expense that might be incurred. It is more likely that the payments are used to provide employee compensation that is treated as not subject to employment taxes. Employers do not include the rental payments in the employee’s wages. Consequently, the employers reduce their liability for employment taxes.

  7. The issue to be determined with respect to equipment rents is whether employees who furnish and maintain their own equipment are reimbursed for such expenses under an accountable plan. A reimbursement or other expense allowance arrangement will be treated as a nonaccountable plan if it fails to meet any one or more of the requirements of business connection, substantiation, or return of excess.

4.23.5.15.1  (08-31-2012)
Accountable Plan – Per Diem Payments and Wage Recharacterization

  1. If an expense reimbursement plan serves to recharacterize amounts previously paid as wages, amounts paid under it will not be treated as paid under an accountable plan. Such recharacterization violates the business connection requirement of Treas. Reg. 1.62-2(d) because the employees receive the same amount regardless of whether expenses are incurred, the only difference being the ratio of the amount treated as taxable wages to the amount treated as nontaxable reimbursement. Consequently, all reimbursement allowances paid under the plan must be treated as paid under a nonaccountable plan, must be included in the employee's gross income, and must be reported as wages for FICA tax, FUTA tax, and income tax withholding purposes. The recharacterization as a reimbursement allowance of amounts previously paid as wages violates the business connection requirement of Treas. Reg. 1.62-2(c) regardless of whether the employee actually incurs (or is reasonably expected to incur) deductible business expenses related to the employer's business. See Rev. Rul. 2012-25 .

  2. An emerging issue is the bifurcation of wages between taxable wages and per diem payments, most often paid to employees who provide services through a temporary staffing service or other temporary employment arrangement and have to travel for the job. The payment arrangement typically pays the employee an hourly rate, but the rate is divided between taxable wages and "per diem" payments. The combined rate is comparable to the taxable wage rate paid to employees who work in the same location but do not travel for the job.

4.23.5.16  (11-03-2009)
Procedures at Conclusion of Examination

  1. At the conclusion of the examination, discuss findings with the taxpayer. Explain the government’s position in a convincing and professional manner. The objective is to obtain the greatest possible number of agreements without sacrificing the quality or integrity of examination determinations, which follows Policy Statement 4–40, Early agreement primary objective. Refer to IRM 1.2.13.1.16.

  2. The closing conference will be productive if the taxpayer and representative are kept informed of the issues throughout the examination. This includes reviewing in detail with the taxpayer and representative any Form 5701, Notice of Proposed Adjustment, issued before the closing conference.

  3. Determine if any information return penalties are applicable regardless of whether the forms are obtained during the examination or the taxpayer is permitted a delayed submission. See IRM 4.23.9, Employment Tax - Employment Tax Penalty and Fraud Procedures. If there is no reason for waiver of the penalties, propose and process the penalty package at the same time as the examination package. See IRM 4.23.8.11, Information Return Penalty Case File, for instructions on the penalty package.

  4. Solicit payment for deficiencies if an agreement is indicated. See IRM 4.23.11, Employment Tax - Prompt Action in Deficiency and Overassessment Cases, for instructions on prompt action in deficiency and overassessment cases.

  5. A Form 2504, Form 2504-S, or Form 2504-WC will be accepted only when it discloses the date of calendar quarters involved, the return form number, the amount of the deficiency, overassessment or penalties if any, and is properly signed by the taxpayer or taxpayer’s representative. Under no circumstances will a waiver which has been completed by the taxpayer be altered by Service personnel, nor will the taxpayer be requested to execute a waiver in blank. A Form 2504 is considered a valid claim for refund when a taxpayer agrees to an overassessment determined by the Service. The date of receipt of the executed Form 2504 will be indicated in the upper right corner of the form. See IRM 4.23.10.15, Agreed Employment Tax Reports, for instructions on processing these cases.

4.23.5.16.1  (08-31-2012)
Alternative Dispute Resolution

  1. If the taxpayer indicates disagreement with any of the proposed adjustments, solicit and consider a formal statement of the taxpayer’s position on each unagreed issue before concluding the examination. If agreement cannot be reached, explain the procedure for administrative appeal as well as the option to pay any deficiency and file a claim for refund if the taxpayer or taxpayer’s representative is not conversant with these procedures. Provide Publication 5, Your Appeal Rights and How to Prepare a Protest If You Don't Agree, to the taxpayer. Alternate dispute resolution strategies are fully discussed in IRM 4.46.5.5.2, Alternative Dispute Resolution (ADR) Tools and Procedures.

  2. When taxpayers disagree with proposed adjustments, it is beneficial to all parties to resolve disputes at the lowest level possible. IRC 7123 provides for alternative dispute resolution techniques by Appeals. This code section was added by section 3465 of the IRS Reform and Restructuring Act of 1998. Two processes that may expedite dispute resolution are early referral to Appeals and Fast Track Mediation.

  3. Early Referral: If the examiner and taxpayer are unable to reach agreement on one or more issues, the taxpayer should be encouraged to request early referral of these unagreed issues to Appeals. Certain employment tax issues that are appropriate for referral are described in Rev. Proc. 99-28, 1999-2 C.B. 109, and include the following:

    1. Worker classification issues.

    2. Liability issues such as the applicability of section 530, IRC 3509 rates, and interest free adjustments.

    3. Other issues such as whether certain payments are excepted from the definition of wages, e.g., fringe benefits.

  4. Fast Track Mediation: Another method designed to expedite the resolution of tax disputes with taxpayers at the earliest opportunity is through Fast Track Mediation (FTM). Either the examiner or the taxpayer can propose mediation. FTM involves an appeals or settlement officer who has been trained in mediation techniques acting as a mediator between the taxpayer and Compliance. At the completion of a disputed determination, the examiner or manager will inform the taxpayer of the opportunity to request FTM to resolve the case. Both the Service and the taxpayer must complete and sign a simple agreement to use mediation. The mediator facilitates the discussion but cannot impose resolution. The taxpayer and the Service must agree on any resolution. Issues not resolved can follow the normal appeal process. See Publication 3605, Fast Track Mediation - A Process for Prompt Resolution of Tax Issues, for more information on FTM.

  5. The enactment of IRC 7436 does not change these early referral procedures. If the issues are approved for transfer from Compliance to Appeals, the examiner will continue to develop other issues arising in the audit and will solicit consents from the taxpayer to extend the limitations period for assessment as appropriate.

  6. TAS: The Taxpayer Advocate Service (TAS) is an independent organization within the IRS whose employees assist taxpayers who are experiencing economic harm, who are seeking help in resolving tax problems that have not been resolved through normal procedures, or who believe that an IRS system or procedure is not working as it should. Pub 1546, Taxpayer Advocate Service - Your Voice at the IRS, provides contact and additional information. The program is designed to alleviate taxpayer hardships that arise from systemic problems or the application of the Internal Revenue Code. In addition, see the TAS website at: http://tas.web.irs.gov.

4.23.5.16.2  (08-31-2012)
Correction of Error on Form 2504

  1. If an error was made in computing the deficiency, overassessment, or penalty shown on a Form 2504, Agreement to Assessment and Collection of Additional Tax and Acceptance of Overassessment, previously obtained, it will not be necessary to obtain a new Form 2504 if correction of the error is in favor of the taxpayer. In such case, the correct deficiency or penalty should be assessed or the correct overassessment scheduled for refund. An explanation of the correction should be made in the Employment Tax Examiner's Report (ETER) to the taxpayer.

  2. If the correction of an error against the taxpayer is minor in amount, the case will be processed for the amount of the deficiency, overassessment or penalty shown by the original waiver and a suitable explanation will be included in the ETER to the taxpayer. Refer to IRM 4.10.2.3.1, Large Unusual Questionable Items (LUQs) Defined, for tolerance levels.

Exhibit 4.23.5-1 
Determining the Right to Direct or Control

Behavioral Control Facts that illustrate whether there is a right to direct or control how the worker performs the specific task for which he or she is hired:
• Instructions
• Training
Financial Control Facts that illustrate whether there is a right to direct or control how the business aspects of the worker’s activities are conducted:
• Significant investment by the worker
• Unreimbursed expenses
• Services available to the public
• Method of payment
• Opportunity for profit or loss by the worker
Relationship of the Parties Facts that illustrate how the parties perceive their relationship:
• Employee benefits
• Intent of parties/written contracts
• Permanency
• Discharge/Termination
• Regular business activity

Exhibit 4.23.5-2 
Employment Tax Treatment for Various Categories of Workers

Type of Worker Income Tax
Withholding
FICA FUTA
Common Law Employee - IRC 3121(d)(1) Withhold Taxable Taxable
Corporate Officer - IRC 3132(d)(2) Withhold Taxable Taxable
Statutory Employees - IRC 3121(d)(3)
Agent or Commission Driver - IRC 3121(d)(3)(A) No Withholding Taxable Taxable
Full-time Life Insurance Salesperson - IRC 3121(d)(3)(B) No Withholding Taxable Exempt
Full-time Traveling or City Salesperson - IRC 3121(d)(3)(C) No Withholding Taxable Taxable
Home Worker - IRC 3121(d)(3)(D) No Withholding Taxable if paid $100 or more in cash during the calendar year Exempt
218 Employee - IRC 3121(d)(4) Withhold Taxable Exempt
Statutory Non-Employees
Qualified Real Estate Agent — IRC 3508(b)(1) No Withholding Exempt* Exempt
Direct Seller — IRC 3508(b)(2) No Withholding Exempt* Exempt
Companion Sitter — IRC 3506 No Withholding Exempt* Exempt

* However, statutory non-employees are subject to SECA

Exhibit 4.23.5-3 
Statutory Employees

FICA Statutory Employee Rules
 In addition to common law employees, FICA Rules provide for statutory employees, which include: (1) agent drivers and commission drivers, (2) full-time life insurance salesmen, (3) home workers, and (4) traveling or city salesmen.
General Requirements
 The four occupational groups are briefly covered in Treas. Regs. 31.3121(d)–1. Workers in these four occupational groups who meet the following requirements are employees, for FICA purposes only, if they do not meet the common-law test:
 1. The contract of service contemplates that the worker will personally perform substantially all the work, and
 2. The worker has no substantial investment in facilities other than transportation facilities used in performing the work, and
 3. There is a continuing work relationship with the person for whom the services are performed.
Contract of Service. Work performed in these occupational groups is done under a contract of service. The term "contract of service" , means the arrangement, oral or written, under which the work is done. This arrangement must contemplate that the worker will do substantially all the work. Thus, if the contract contemplates that the worker will do all the work personally and the alleged employer does not acquiesce in delegating part of this work to another, the fact that the worker does so would not preclude his coverage under this section. The important thing is not whether the worker delegates part of the work to another, but rather whether the arrangement contemplates the worker will do so. The mutual intent of the parties governs.
 Sometimes a worker delegates part of his work to another when his contract or work agreement expressly forbids doing so. Conversely, the contract may contemplate a delegation of part of the work and the worker performs all the services himself. The examiner should determine whether the contract of service is being violated or whether it was modified to permit the change.
 A contract which contemplates hiring a chauffeur would not affect the personal service requirement because the services of the chauffeur are incidental to the selling activity. Similarly, the right to hire a substitute or assistant occasionally would not preclude qualifying for this provision.
Substantial Investment in Facilities. The term "substantial investment" refers to substantial facilities being furnished by the worker for conducting the business; they cannot be precisely defined. All the facts of each case must be considered to determine whether the facilities furnished by the worker for the work are substantial. Several factors listed below will be considered in these determinations:
 1. What is the value of the worker’s investment compared to total investment?
 2. Are the facilities furnished essential to the work or for the personal convenience of the worker?
 3. Are the facilities being purchased or leased from the person for whom the services are performed?
 4. Are the facilities furnished by the worker considerably more extensive than those usually furnished by other workers performing comparable services?
 Facilities include such items as office furniture and fixtures, premises, tools, and machinery. An expense may or may not relate to furnishing facilities. Expenses for facilities (for example, expenses for an office, store, showroom, warehouse, stenographic service, utilities, etc.) may be considered in determining whether the facilities furnished represent a substantial investment. Generally, a worker who maintains an office in his own home does not have a substantial investment, but the worker who maintains an office outside his home frequently has a substantial investment in facilities.
Facilities do not include:
 1. Education, training or experience, or goodwill,
 2. Tools, instruments, or clothing commonly or frequently provided by employees,
 3. A vehicle for the worker’s transportation, or
 4. Transportation facilities for carrying the goods or commodities or for supplying laundry or dry-cleaning services.
Continuing Relationship. Work is considered to be of a continuing nature if it is regular or frequently recurring. Regular part-time work (for example, 2 days a week), is considered a continuing relationship. Regular seasonal employment is also work of a continuing nature. A single-job transaction, even though it takes a considerable period of time, is not generally a continuing relationship.
Specific Requirements
(1) Agent-Driver or Commission-Driver
 This group is limited to workers who distribute meat or meat products, vegetables or vegetable products, fruit or fruit products, bakery products, beverages (other than milk), or laundry or dry-cleaning services. These products and services are defined in their commonly accepted sense. The worker may sell at retail or wholesale establishments. He may operate from his own truck or one belonging to the company for which he works. Ordinarily, he services customers designated by the company as well as those he solicits. The following requirements, in addition to the three general requirements previously listed, must be met if the worker is to qualify as a statutory agent-driver or commission-driver.
The Worker Must Distribute One or More of the Types of Products or Services Listed Above. He may also be engaged in distributing products or services in addition to these if handling the additional products or services is incidental to handling the specified items. If the products are sold for the same principal, all the services are considered within the occupational category. A rule of thumb is that the services are incidental if the time spent handling the additional products or services is 20 percent or less of the time spent handling all products or services. If the time factor does not appear realistic, consider other factors such as ratio of income. If distributing additional products or services for the same principal is not incidental to handling the products or services listed above, the worker is not an employee. If the worker distributes for more than one principal, his services for each principal will be considered separately.
The Worker Must Perform the Services for the Person Engaging Him. The worker, who on his own account, buys merchandise and sells it, or furnishes services to the public as a part of his own independent business, is not included in this occupational category.
(2) Full-Time Life Insurance Salespersons
 Ordinarily, this group includes salespersons whose full-time occupation is soliciting life insurance applications and/or annuity contracts primarily for one life insurance company. They are usually furnished with office space, stenographic help, telephone facilities, forms, rate books and advertising materials by the company or its general agent.
 In addition to meeting the three general requirements, an individual must be a full-time life insurance salesperson, that is, one whose entire or principal business activity is devoted to soliciting life insurance and/or annuity contracts primarily for one life insurance company. Generally, the contract of employment will show whether a salesperson meets these requirements.
 The intention of a salesperson and his or her company, shown by the contract of employment and their mutual performance, not the time devoted to the work, will govern in determining whether an individual is a full-time or a part-time salesperson. Thus, the entire or principal business activity of an insurance salesperson will be considered to be soliciting life insurance or annuity contracts if their arrangement with a life insurance company provides for soliciting life insurance or annuity contracts (or for soliciting such contracts and only incidentally soliciting accident and health insurance contracts) for such company as their entire or principal business activity.
Intent Expressed in Contract. When the contract clearly shows that full-time services are intended, a salesperson meets the full-time requirement. On the other hand, if part-time services are contemplated by the contract, a salesperson is not a statutory employee. This applies, regardless of the amount of time devoted to the work, unless a question is raised that the contract does not show what both parties originally or later intended.
Deviation From Original Intent—Parties Agree. If the performance of a salesperson is not consistent with the written contractual terms, determine whether the parties came to a mutual understanding on the deviation. If the parties agreed to the change in their original agreement or the company acquiesces in it, a salesperson’s status will be modified, effective with the date the change took place. Their status before that date will be governed by the terms of the original contract.
Deviation From Original Intent—Parties do not Agree. If the performance of a salesperson is not consistent with the contract terms and the company knows of the inconsistency but refuses to change the original agreement or to acquiesce in the deviation, determine whether there is a reasonable basis for the company’s position.
Example of Reasonable Position. The company has a set policy restricting the number of full-time salespeople it may employ in a certain territory and notifies all its salespersons under part-time contracts of this policy. It is aware that some of its part-time salespersons are devoting their whole time to selling for the company, but it discourages this custom and treats such salespersons as part-time workers in every respect, that is, pays them at a lower rate of commission than a full-time salesperson and does not include them in its pension and bonus plans, etc.
Example of Unreasonable Position. The company considers all its salespeople full-time if they work exclusively for their company. The company may know that only one hour a month is devoted to the sale of insurance by the salespersons, and the remainder of their time is spent in other work.
 If the company’s position is reasonable, a salesperson’s status will be determined by the terms of the contract, regardless of his work history. However, if the company’s position is unreasonable, a salesperson’s status will be determined by a complete evaluation of the situation.
Intent Not Expressed in Contract—Parties Agree. If there is no written contract, or the contract does not clearly reveal the mutual intent of the parties on the full-time or part-time aspects of the relationship, a salesperson’s status will be determined by the mutual intent of the parties shown by their answers to questions.
Intent Not Expressed in Contract—Parties Do Not Agree. If the contract does not show whether full-time or part-time services are intended and the parties disagree, the determination of a salesman’s status will be based on a complete factual evaluation. Whether a salesperson’s work for the company is their entire or principal business activity will be decided after considering the factors discussed in the following paragraphs under those headings. The company's classification of a salesperson should be given considerable weight, if there is a reasonable basis for the classification.
Concept of "An Entire Business Activity." An entire business activity may or may not be full-time. A salesperson does not necessarily have to spend 8 hours a day, 5 days a week, in one sole business activity to meet the full-time requirement. A salesperson may work regularly a few hours a day and qualify as a full-time insurance salesperson if other factors in the work relationship indicate a full-time status.
 On the other hand, many salespersons work for only one firm but spend only an hour or two a day, or a day or two a week, at their occupations or make sales only occasionally. Generally, even though the services are a salesperson’s only work effort, they are not substantial enough to be considered an "entire business activity." In other words, a salesperson is not an employee if his/her efforts are so irregular, intermittent, or sporadic that they would be considered not to be engaged in any business activity.
Concept of "A Principal Business Activity." A principal business activity is one which takes the major part of a salesperson’s working time and attention. When a salesperson is engaged in several business activities, it is necessary to determine his/her principal business activity. In making this determination, consider factors such as:
 1. The opinions of the parties involved. A statement by the company that a salesperson is or is not required to devote their work effort principally to the sales of its policies should be given considerable weight. A similar statement by a salesperson should be supported by other evidence.
 2. The salesperson’s total working time, that is, the amount of time they spend in connection with all of their business activities. What proportion of that time do they spend in soliciting for the firm?
 3. The ratio of their earnings from the services to their total earnings. Does the ratio indicate that the major part of their income comes from this firm?
 4. Insurance companies usually treat part-time and full-time salespersons differently for commission rates, renewal schedules, pension plans, etc. In what category has the company placed the salesperson?
Type of Insurance Sold. The salesperson’s efforts must be devoted principally to soliciting life insurance or annuity contracts. Occasional or incidental sales of other types of insurance, such as accident and health insurance will not affect this requirement. However, a salesperson who is required to devote substantial effort to selling applications for insurance contracts other than life insurance or annuity contracts (e.g., accident and health, fire, automobile, etc.), does not meet the requirement.
Life Insurance Subagents. It may sometimes be necessary or desirable to determine whether life insurance subagents are employees of the general agent or of the insurance company. Generally, subagents hired by the general agent are employees of the insurance company if the contracts of employment are countersigned or approved by the insurance company. If not, fully explore the contractual arrangements to determine whether the general agent or the insurance company is the employer.
 If the subagents are found to be employees of the general agent, this fact will usually preclude the general agent from meeting the personal service requirement since he may, if he chooses, delegate a substantial part of the sales services to his subagents. In addition, most general agents cannot meet the full-time requirement. The various services required of them in operating and supervising their general agencies indicate that it is not contemplated that they devote their full time to soliciting life insurance or annuity contracts.
(3) Homeworkers.
 This group generally includes people who make buttons, quilts, gloves, bedspreads, clothing, needlecraft products, etc. The work is done away from the employer’s place of business, usually in the worker’s own home, the home of another, or in his own workshop. The work is done on goods or materials furnished by the employer and in accordance with the employer’s specifications. The worker returns the processed material to the employer or to a person designated by the employer.
Specific Requirements for Homeworkers Services Performed After 1954. To qualify as an employee, the homeworker must meet, in addition to the three general requirements previously listed, the following requirements:
 1. They must do the work in accordance with specifications given by the employer. Generally, these specifications are simple and consist of patterns, samples, etc.,
 2. The material or goods on which the work is done must be furnished by the employer, and
 3. The finished products must be returned to the employer or a person designated by them. It is immaterial whether the employer calls for the work or the worker delivers it to them.
Special Wage Requirement for Homeworkers. A homeworker who meets the requirements is a statutory employee. However, IRC 3121(a)(10) provides that the pay which they receive for such work is not wages unless $100 or more in cash is received by the wage earner in the calendar year from one employer. Thus, a homeworker may be employed by several employers, but if their pay from one employer is to constitute wages, they must receive at least $100 cash in the year from that employer. If the $100 cash-pay test is met, all the non-cash pay from the same employer can be included as wages.
(4) Full-Time Traveling or City Salespersons.
 This category includes the salesperson who operates away from the employer’s premises. His/her full-time business activity is selling merchandise for a principal employer. The test of "full-time" relates to an exclusive or principal business activity for a single firm or person, and not to the time spent on a job. Side-line sales activities for some other person do not exclude a salesperson from coverage.
 Salespersons are ordinarily paid on a commission basis. Generally, they are not controlled as to the details of their service or the means by which they cover their territories. However, they are expected to work their territory with some regularity, take orders, and send them to the employer for delivery to the purchaser. This group does not include agent-drivers or commission-drivers.
 In order for a traveling or city salesperson to fall within the statutory test, they must meet, in addition to the three general requirements, the following requirements:
 1. Their entire or principal business activity must be devoted to soliciting, on behalf of and transmitting to his principal, orders for merchandise,
 2. The orders must be obtained from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments, and
 3. The merchandise they sell must be bought for resale or must be supplied for use in the purchasers’ business operations.
 The definition of an entire and a principal business activity, given under "Full-time life insurance salesperson" applies here. In addition, you should consider whether the contractual arrangement requires devoting a major portion of the salesperson’s time and efforts to sales activity for the firm.
They Must Work for One Principal Employer. A worker who buys merchandise and sells it on their own account is not included in this occupational category. Neither is a manufacturer’s representative who holds themselves out as an independent businessperson and serves the public through their connection with a number of firms.
 The multiple-line salesperson generally is not an employee because his/her principal business activity is not soliciting orders for one principal. However, a salesperson who solicits orders primarily for one principal is not excluded because of side-line activities on behalf of other persons or firms. The salesperson may be an employee of the person for whom the orders were principally solicited.
Classes of Purchasers. Salespersons must sell to the classes of purchasers described in IRC 3121(d)(3)(D). They may also sell incidentally to others. In addition to considering the percentage of a salesperson’s total working time spent in soliciting orders from the specified classes of purchasers, other factors, e.g., rates of income, number of sales, etc., should also be considered. If the sales to excluded purchasers are incidental, all of the salesperson’s services for its principal are considered within the occupational category.
 1. A wholesaler buys merchandise in large quantities and usually sells in small quantities to jobbers or to retail dealers but not to the ultimate consumer. The wholesaler does not process the merchandise in any way to cause it to lose its identity.
 2.  A retailer deals in merchandise by selling it in small quantities, usually to persons who consume or use it.
 Retail establishments may perform service functions or processing or manufacturing operations with respect to the items they sell without losing their character as retail establishments. For example, a store which sells drapery and slip cover material and makes draperies and slip covers for the consumer is a retail establishment and not a manufacturer. A neighborhood bakery is essentially a retail store, even though it changes the form of raw or prepared materials.
 3.  Contractors include such service organizations as window-washing contractors, wall cleaning contractors, other service contractors, and construction contractors.
 4. The phrase "other similar establishments" refers solely to establishments similar to hotels and restaurants. It is limited to establishments whose primary function is furnishing food and/or lodging.
Status of Purchasers Composed of Several Business Units. An entity not within the included classes of purchasers may, through a unit of its organization, carry on a clearly identifiable and separate business which is in the included category. A salesperson who solicits orders from the entity for merchandise for resale by or for use in business operations in that unit has met the requirement regarding "classes of purchasers." For example, sales made to an unincorporated university bookstore, owned and operated by the university, are sales made to a purchaser included in the statutory definition of "traveling or city salesman."
Merchandise for Resale or Supplies for Use in Purchaser’s Business Operations. Merchandise must be for resale or for use in the business operations of the purchaser. The phrase "merchandise for resale" includes only tangibles which do not lose their identity as they pass through the hands of the purchaser. The phrase "supplies for use in the business operations" means supplies principally used in conducting the purchaser’s business. Generally, it includes all tangible merchandise not considered "merchandise for resale." Services such as radio time, advertising space, etc. are intangible and outside of this definition. However, advertising novelties, calendars, etc. constitute supplies within this definition.
 The fact that a salesperson performs substantial work in servicing the article she sells, does not necessarily preclude their meeting the requirements of IRC 3121(d)(3)(D). For example, a salesperson that spends a day selling a machine and a day supervising its installation and perhaps training the purchaser’s personnel in its use may still have performed services as a full-time salesperson. Furnishing such services by a salesperson may be a necessary part of the inducement for the buyer to purchase. The question, therefore, is whether their total activity is essentially a selling activity. If it is, the services related to such sales, even though substantial, are an integral part of the sale. If it is not, they do not meet the requirements for coverage.

Exhibit 4.23.5-4 
Employer-Employee Relationship Cases

The following is a partial list of cases dealing with the issue of worker classification - there are many other cases. The cases are not listed in any particular order.

Ewens and Miller v. Comm, 117 T.C. 263 (2001) In finding that bakery workers and cash payroll workers were common law employees, the Tax Court stated that "whether a worker is a common law employee or an independent contractor, for employment tax purposes, Tax Court considers: (1) degree of control exercised by the principal, (2) which party invests in work facilities used by the worker, (3) opportunity of the worker for profit or loss, (4) whether principal can discharge the worker, (5) whether work is part of principal's regular business, (6) permanency of relationship, and (7) relationship parties believed they were creating. 26 U.S.C.A. §3121(d)." The case also discusses statutory employees.
Avis Rent A Car System. Inc. v. United States, 503 F.2d 423 (2d Cir. 1974) Car shuttlers were employees, despite the transient nature of their relationship with the employer. The court found 7 relevant non-exclusive factors from U.S. v. Silk, 331 U.S. 704 (1947) and Bartels v. Birmingham, 332 U.S.,126 (1947) including working in the course of the service recipient’s business (integration).

The importance of avoiding single-fact analysis is stressed in this case holding car shuttlers to be employees. Facts considered relevant include: 1) the right to control the manner in which work is performed, 2) substantial investment, 3) expenses, 4) ability to profit, 5) special skills, 6) permanence, and 7) whether the services performed by the worker were part of the principal’s regular business activity.
Ellison v. Commissioner, 55 T.C. 142, 144, 153, 156 (1970) acq. 1971–2 C.B. 2 A worker was an employee of a life insurance company and thus a stock option granted by the company was a restricted stock option. The worker did not bargain with the company with respect to the terms of the working agreement. The fact that an employee has an opportunity to exercise his own faculties in the business of the employer does not negate the employment relationship. The court found that a provision in the contract indicating there was no employment relationship was not significant.
McGuire v. United States, 349 F.2d 644, 646 (9th Cir. WA 1965) Truck unloaders ("swampers" ) required little supervision because the nature of the work was uncomplicated and they were generally familiar with the procedures of the job. "The absence of need to control should not be confused with the absence of right to control. The right to control contemplated by the regulations relevant here and the common law as an incident of employment requires only such supervision as the nature of the work requires."
James v. Commissioner, 25 T.C. 1296, 1301 (1956) A doctor was an employee of hospitals for which he performed services. "(T)he control of an employer over the manner in which professional employees shall conduct the duties of their positions must necessarily be more tenuous and general than the control over nonprofessional employees." "(T)he general control of the hospitals over petitioner.... coupled with the controls over his method of working furnished by the high standards of his profession...., are sufficient to constitute petitioner an employee rather than an independent contractor."
Professional and Executive Leasing, Inc. v. Commissioner, 862 F.2d 751 (9th Cir. 1988) A case similar to James above - Both cases focus on the right to control the manner in which the work of highly skilled professionals is performed.
Alsco Storm Windows, Inc. v. United States, 311 F. 2d 341, 343 (9th Cir. WA 1962) Although no one factor is controlling, the test usually considered fundamental is whether the person for whom the work is performed has the right to control the activities of the individual whose status is at issue, not only as to the results, but also as to the means and method to be used for accomplishing the results.
Nationwide Mutual Insurance Co. v. Darden, 503 U.S. 318 (1992) In this case under Title I of the Employee Retirement Income Security Act of 1974 (ERISA), the Supreme Court held that traditional common law concepts should be used to interpret the term "employee" absent legislative direction to the contrary.
Weber v. Commissioner, 103 T.C. 378 (1994), aff'd per curiam 60 F.3d 1104 (4th Cir. 1995) The importance of small factual differences is apparent in Weber, a Methodist minister was held to be an employee. Compare with Shelley.
Shelley v. Commissioner, T.C. Memo 1994-432 The importance of small factual differences is apparent in Shelley, a clergyman in another denomination was held to be an independent contractor. Compare with Weber.
Grey v. Commissioner, 119 T.C. 121 (2002), aff’d, in unpublished opinion, 93 Fed.Appx. 473 (3rd Cir 2004) This case analyzes the employment status of an individual who is the president and sole shareholder of a corporation under IRC section 3121(d)(1), and concludes that the individual performed services for the corporation in his capacity as president, and therefore, was an employee for employment tax purposes under IRC section 3121(d)(1).
Kenney v. Commissioner, T.C. Memo 1995-431 The Tax Court noted that the business’ intent was inconsistent with both the substance of the employment relationship and what the parties actually knew the relationship to be. The court found that the business knew that the workers were employees, but it called them independent contractors because the business did not want to pay employment taxes on them or include them in employee benefit plans.
Veterinary Surgical Consultants, P.C. v. Commissioner, 117 T.C. 141 (2001), aff’d in unpublished opinion sub nom. Yeagle Drywall Co. v. Commissioner, 54 Fed. Appx. 100 (3d Cir. 2002) President of S corporation was an employee and amounts taxpayer paid it were wages for purposes of federal employment taxes. All of taxpayer’s income was generated by consulting and surgical services the president performed. (He was the sole shareholder and the only worker.) The Tax Court found that taxpayer had no reasonable basis for treating the president as other than an employee; thus, taxpayer was not entitled to relief under section 530.
Simpson v. Commissioner, 64 T.C. 974 (1975) The IRS successfully argued in this case that an insurance agent was an independent contractor. Relevant facts were: 1) degree of control over details; 2) investment in facilities; 3) opportunity for profit or loss; 4) right to discharge; 5) whether work is part of principal's regular business; 6) permanency; and 7) the relationship the parties believed they were creating.

Exhibit 4.23.5-5 
Section 530 Flowchart

                         
  Were 1099s filed? YES Consistent Treatment YES Reliance on Prior Audit YES 530 Relief  
         
                         
    NO     NO     NO        
                         
  No 530 Relief for periods 1099′s were not filed   No 530 Relief   Reliance on Court Case, PLR, etc.? YES 530 Relief  
         
                         
                NO        
                         
              Reliance on Industry Practice? YES 530 Relief  
                 
                         
                NO        
                         
              Reliance on Other Reasonable Basis? YES 530 Relief  
                 
                         
                NO        
                         
              No 530 Relief        
                     
                         

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