Market Segment Specialization Program (MSSP)
Table of Contents
IntroductionThis report is a culmination of the results of the work performed by a team of individuals from Examination, Collection, and the State of Oregon Revenue Department. The primary objective of this group was to evaluate compliance within a specific group of taxpayers and to develop an industry/project report to be used as a reference tool by State and Federal examiners. A team audit approach was used to maximize audit resources and develop communication lines between the State of Oregon Revenue Department, the Examination Division, and the Collection Division of the Internal Revenue Service.
The team consisted of four revenue agents from Examination, one revenue officer examiner from Collection, one tax auditor from Examination, one revenue agent from the State of Oregon, and an audit accounting aide from Examination. The audit techniques presented in this report were used by the examiners and have been found to be useful within this industry.
The basic goals of the members of this team are outlined below:
This report is based upon information gathered from a limited number of examinations. It is, therefore, not to be considered all inclusive or absolute as to its contents. The primary purpose of the report is to provide some general and technical information which should be useful to an examiner in the classification, pre-planning, and examination of returns selected in the reforestation industry.
The audit areas identified and discussed in this report were considered to be significant or unusual enough to warrant comment. The mere fact that an item is addressed in this report does not imply, in any manner, that it must or should be examined in every case. To the contrary, it is intended that the discussion for any one audit area will assist the examiner in deciding whether the item would warrant examination on a case by case basis. This handbook was developed as a reference tool and should be used as a supplement to the manual.
Chapter 1 Return Selection Process
Returns Selected For This ProjectContractors were selected from the list of licensed Farm/Labor Contractor's, provided by the Bureau of Labor & Industry, Wage and Hour Division. A data base of the licensed contractors owning businesses in Salem, Woodburn, Mt. Angel, and the surrounding area was developed. AIMS was researched to locate social security numbers and addresses of the licensed contractors. Once a social security number was obtained, a transcript was ordered to determine if the contractors were filing Federal tax returns. Copies of selected contractors' returns filed with the State of Oregon were secured from the Department of Revenue under our information exchange agreement. The returns examined were selected based on prior knowledge of the types of expenses common to the reforestation industry and whether or not the items reported on the return appeared either large or unusual. The returns selected for examination were either individual Forms 1040, Subchapter S-Corporations, or C-Corporations. The group examined 9 prime contractors, 3 second-tier subcontractors, and 20 individuals who filed Federal returns Form 1040. The State of Oregon revenue agent examined the Corporate Income Tax Returns for three S-Corporations and one C-Corporation. The second-tier contractors were selected by expanding the "package audit" during the examination of the prime contractor. In other words, when a prime contractor was audited, the examiners reviewed certain documents (such as canceled checks, invoices, and Forms 1099) pertaining to subcontractor payments. The subcontractors who received large payments were identified and again transcripts were requested to determine if they filed Federal and State tax returns. We selected subcontractors that were filing employment tax returns and also subcontractors that were not filing either income tax returns or employment tax returns. During the classification process and the examination process, the group identified audit issues which appeared to be common within this industry. The following is a list of the audit areas that were identified:
Step 1: Identifying the Prime ContractorReforestation contractors working in Oregon are required to obtain a Farm/Labor Contractor's License. To secure a listing of licensed Oregon contractors you need to contact the State of Oregon, Bureau of Labor and Industries, Wage and Hour Division. Oregon is the only known state that requires the contractors to have a license; however, the Bureau of Labor and Industries in your state will be able to give you more information on their policies.
Another possible resource for locating reforestation contractors is PSPB or the Department of Revenue in your state. PSPB and the Department of Revenue have the capability of running a listing of returns with specific Principle Industry Activity Codes, (PIA Codes). This may be something that your Disclosure Officer can secure for your area. Finally, you may be able to request a list of contractors from the Forest Service or the Bureau of Land Management. These agencies are required to maintain a current mailing list of contractors who wish to receive the current announcements of solicitations. Chapter 2 of this handbook, lists addresses, and telephone numbers of Oregon and Washington regulatory and licensing offices where you can secure information about reforestation contractors.
Step 2: Selecting Second-tier Contractors for ExaminationWhile completing the expanded "package audit" the examiner should concentrate on those subcontractors with the highest dollar volume. A good starting point is to review the Forms 1099. In addition, the disbursements journal should be reviewed for other large volume contractors who were not issued a Form 1099, since, 1) the prime contractor may not be issuing a Form 1099 to all subcontractors, and 2) Forms 1099 are not required to be issued to corporations, and contractors are sometimes organized as corporations to circumvent the Form 1099 filing requirements.
Step 3: Identifying Disbursements to the Selected SubcontractorsIn preparation for reviewing the key documents (canceled checks), disbursements made to the subcontractors selected in Step 2 must be identified by check number, date, and amount. It has been our experience that the contractors do not maintain summaries of their cash disbursement journal so it will be helpful to create a data base of payments made to individuals and the checks issued to cash. This information will be invaluable for the following reasons:
Step 4: Inspect Canceled ChecksThe next step is to pull the checks for each selected contractor and to review the endorsements. The examiner will be looking for checks that were cashed in unusual ways. For example, they may have been converted to cashier checks, cashed at the payor's bank, cashed at a check-cashing business, deposited to a bank account located in another city, or endorsed to another individual. Because contractors normally operate as closely held family businesses, with few accounting controls in place, failure to deposit normal business receipts is a good indication that the income is not being reported for tax purposes.
Step 5: Select Subcontractors for AuditAfter completion of Step 4, the examiner will have identified one or more contractors whose audits will spin-off. He or she would be well advised to request the payment detail for these contractors for the subsequent year as well. Requesting information in the early stages is advisable since it may become increasingly difficult to obtain documents as the audit progresses.
Step 6: Secure Documents for the Subcontractor FileThe information to be accumulated for each contractor that will be spun-off should include as much of the following as is available:
Step 7: Other Sources of Information for Locating SubcontractorsIf the address or social security number retained by the prime contractor does not help you in locating the subcontractor, you can call the Corporate Commissioner to obtain the address of the business and the names and addresses of the registrants. We have found that it is common for individuals to register an assumed business name with the Corporate Commissioner and give the name and address of several registrants. (For information on Oregon businesses you can call (503) 378-4166). The Department of Insurance and Finance can be a helpful source for locating subcontractors. This agency maintains a list of individuals and businesses who currently have worker's compensation coverage. If the subcontractor currently has coverage, you can obtain .his or her home address. The Department of Insurance and Finance can also give you information about a business and tell you whether or not the business has registered for coverage as a partnership, corporation, or as a sole proprietor. (In Oregon you can call (503) 378-4954). As previously mentioned, the Bureau of Labor and Industries, Wage and Hour Division will have names and addresses of all licensed contractors. (In Oregon you may call (503) 378-3292).
Chapter 2 Nature Of Operations
Overview Of The IndustryThis MSSP Guide is designed to assist examiners in completing examinations of reforestation contractors. A contractor working in the reforestation industry may secure service contracts, (pre-commercial thinning and tree planting contracts) from a Federal agency, a State agency, from private companies, or other contractors. Keep in mind that State and Federal agencies issue several types of service contracts; examples are fire .fighting, cone collection, tree netting, tree shading, gopher baiting, etc. At this time it does not appear that the reforestation-station contractors bid for service contracts other than tree planting and tree thinning. However, no industry is stagnant and this may be something that contractors may expand into in the near future as they develop expertise in the reforestation industry. Since the most predominant type of service contract issued by the Federal and State agencies are pre-commercial thinning and tree planting contracts, the scope of this Guide has been limited to reforestation contracts only.
Federal and State Agencies Issuing Reforestation ContractsThe following Federal and State agencies have the .authority to solicit individuals to do pre-commercial thinning and tree planting:
Private Companies Issuing Reforestation ContractsThere are many private companies involved in producing timber products who may issue tree planting or tree thinning contracts, (that is, lumber mills, sawmills, veneer plants, plywood plants, and in some instances logging companies). Private companies issue tree planting or thinning contacts to either replant or maintain their own timber lands or to comply with the terms of a Federal or State contract. Certain states have legal requirements requiring all forest lands be replanted; these laws may cover both public and private lands. Private companies who purchase timber stands from Federal and State agencies agree to replant the land after harvesting the timber. There is a pattern of these private contractors employing the reforestation contractors on a regular basis.
Copies of contracts issued by private companies were requested; a review of these private contracts did not reveal any significant differences from those issued by the Federal and State agencies. The contracts reviewed by the group were written agreements between the company and the contractor and specify that the reforestation contractors will follow the applicable State and Federal laws while they are engaged to plant trees or for tree thinning.
Federal procurement regulations allow Federal agencies to solicit bids from prospective contractors for three major types of contracts: Service, supply, and construction. As previously mentioned, only service contracts are discussed since pre-commercial thinning contracts and tree planting contracts fall in this area.
Services are considered to be work that requires the direct engagement of the contractor's labor with the goal of performing an identifiable task rather than to furnish an end item of supply. This would include tree planting, tree thinning, cone collection, brush piling, etc. However, the term "service" excludes work done by the construction trades. (The group members have not researched either construction or supply contracts).
The State and Federal agencies have further divided thinning contracts into: 1) pre-commercial thinning contracts and 2) commercial thinning contracts. It becomes important to understand the difference between the two types of thinning contracts since it will enable you to be more successful in obtaining third party information. Probably the most important thing to remember is that these contracts do not fall under the same Federal Regulations nor will one contractor be qualified to work both types of contracts.
Pre-commercial thinning contracts are issued by the Forest Service to thin young forests (10 to 20 years of age). The young forests are thinned to cull undesirable trees, (such as oak, pine, and damaged firs) to give the remaining trees more room to grow.
Commercial thinning contracts, on the other hand, are .issued by the Forest Service to selectively harvest .mature trees. The Forest Service negotiates commercial .contracts have certain lands selectively harvested versus clear cut, as in the case of standing timber sales. Commercial thinning contracts are not considered to be reforestation contracts.
Federal and State contracts are guided by a series of laws and are enforced by several agencies. The Bureau of Land Management, the U.S. Department of Agriculture Forest Service, the Small Business Administration Section 8A Program, and the Oregon Department of Agriculture Forest Service enforce the operational aspects of the contracts guided by various Federal procurement regulations. Other Federal agencies, such as the Department of Labor and the Immigration & Naturalization Service, enforce regulations in relation to wages and the legal status of workers. State agencies are also involved. The state of Oregon's Bureau of Labor & Industry and the Department of Insurance and Finance enforce or monitor regulations governing licensing and Worker's Compensation coverage.
The contractors are required to provide a bond before a Farm/Labor Contractor's License will be issued and provide a certificate of worker's compensation coverage. The cost of the license is $100.
Beginning July 1989, Wage and Hour Division is requiring a $10,000 bond, up from $5,000, and the contractors must take an examination before their license will be renewed. The examination pertains to the laws in various areas, (such as Worker's Compensation, Occupational Safety and Health Administration, Wage & Hour, and Forestry).
Once the contractor has received a license and begins working reforestation contracts, he or she must file a certified payroll every 35 days with the Bureau of Labor and Industries, Wage and Hour Division (BOLI). The certified payrolls will list employee names, their gross wages, and the amount withheld for taxes. BOLI uses the certified payrolls as a measurement device to determine whether or not contractors are complying with State wage and hour laws.
BOLI is looking for contractors who do not pay wages, since the failure to pay wages is grounds for withdrawing the Farm/Labor Contractor's License. All records maintained by BOLI are public. BOLI has changed the expiration date of the Farm/Labor Contractor's License to spread their workload. In prior years all licenses expired on January 31. Currently, the expiration date is determined as follows:
All partners in a partnership must now have a $10,000 bond. A lessor aggregate bond can be negotiated if the contractor has a clean record. The contractors are allowed a 25-percent reduction in the aggregate amount due each year their record stays clean. The minimum bond they would be required to provide would be $10,000 or 25 percent of the total aggregate, whichever is larger.
A corporation will have to provide a bond for the majority shareholder and any other active stockholder in the corporation. The same rules apply to the aggregation and reduction as with partnerships.
The prime contractors and all first-tier subcontractors shall be required to obtain and maintain a Farm/Labor Contractor's License. Contractors not having a current license will be required to furnish evidence of having obtained such license within 10 days after receipt of written notification of the contract award. Failure to obtain, keep, or maintain a current license during the term of this contract or the extension thereof shall be basis for termination or default.
Contractors living in Oregon may bid and receive contracts in other states, (that is, Northern California, Washington, Idaho, etc.). Oregon contractors are not required to have or maintain an Oregon Farm/Labor Contractor's License to work contracts outside of Oregon. However, Oregon contractors who have lost their license normally will continue working in the industry although they now are required to work outside of Oregon.
The Forest Service, the Small Business Administration, and the Bureau of Land Management do not have the authority to ensure that the first-tier subcontractors have a valid license. This causes concern because it allows the prime contractors to use unlicensed subcontractors. The system is not fail proof and Oregon contractors can find ways of hiring unlicensed contractors within the law. You could find an Oregon contractor paying subcontractor payments to a first-tier subcontractor who lives in Oregon but does not have a license. For example, a first-tier sub-contractor, whose tax home is in Oregon, works for an Oregon contractor in California. Whether or not the Federal agencies are able to enforce the licensing requirement at the first-tier subcontractor level depends on their working relationship with the prime contractor.
Another important point to remember is that the State of Oregon, Bureau of Labor & Industries, Wage and Hour Division has no authority to enforce the hourly wage rates set by the U.S. Department of Labor. The State of Oregon has no set amount that must be paid to reforestation workers, with the exception of the minimum hourly wage rate. According to BOLI, they have .tried to set a standard of $6 to $7 per hour for employees in this industry.
SAIF is only one of the companies providing worker's compensation in the State of Oregon. There are approximately 250 worker's compensation insurance companies covering the state. There are six large companies. The three main ones which would probably cover contractors in the reforestation industry are: SAIF, Liberty Northwest, and Employers of Wausau. The Oregon Worker's Compensation rates range from $51 to $34 per every $100 of payroll. This amount varies by year and will go up or down depending on the contractor's work record. According to SAIF, they have had instances where contractors in the assigned risk pool will pay $100 for every $100 of payroll. If you want to check to see if a contractor is currently covered by SAIF you can call (503) 373-8000. SAIF is authorized to release some information without .a subpoena. They can tell us if a contractor is insured, how much the contractor has paid in insurance premiums, how many days were worked, and the amount of payroll reported. We can subpoena their audit reports, correspondence or any claims filed against a contractor.
Reforestation contractors frequently change their business names and the registrants of the business. There could be several reasons why the contractors change the business name or registrants, including attempts to circumvent payment of Worker's Compensation. In Oregon, wage payments made to the owners of the business, (that is, the partners in a partnership, or officers of a corporation) are exempt from worker's compensation coverage.
The Department of Insurance and Finance can tell you if an individual or a business is registered with them as a partnership, corporation, or a sole proprietor. This information may be helpful in determining whether or not all required returns were filed.
The files kept by the Department of Insurance and Finance are public records. However, the Department will not have a file on an employer unless there has been a complaint filed against him or her. If an employee makes a complaint against an employer, Worker's Compensation will send out a Field Investigator.
Worker's Compensation is not concerned about the subcontractor issue because they can hold the prime contractor liable. In fact, they can go back to any State agency or private company who offered the contract, if the prime contractor did not provide worker's compensation. This has been true since 1979. As of July 1989, Worker's Compensation can now go back to any entity who issued the contract with the exception of the Federal Government.
Oregon contractors working in Washington must carry Washington worker's compensation if: 1) the contract exceeds 30 days, or 2) they hire Washington residents.
Bonding RequirementsContractors are required to provide bid bonds and performance bonds in certain instances. The bond can be either a surety bond underwritten by a bonding company or the individual can put up cash or other liquid assets such as stocks and securities. The cash or other liquid assets would be placed in a escrow account and would be available for payment of any unpaid wages due the employees. The interest income earned from the escrow account belongs to the contractor. The performance bond is held in escrow for 150 days after the job is complete. If no complaints are filed, the bond is released.
Currently, Federal agencies are only requiring bonding on service contracts and tree planting contracts over $25,000. The State of Oregon requires a bid bond on all bids over $15,000.