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IRS Compliance Checks

Learn how to navigate an IRS compliance check for independent contractors and classify workers properly for payroll tax purposes.

Q: The IRS recently contacted my business to perform a "compliance check" of the W-2s and 1099s I filed. The agent indicated this wasn't an audit, but rather they would only be looking at the IRS forms my business had filed. What are they looking for and should I be concerned?

A: The IRS is most likely looking for workers you've classified as independent contractors. The government contends that it loses millions, quite possibly billions, of dollars each year on workers who've been classified as independent contractors but who haven't voluntarily paid self-employment taxes.

As you know, when a worker is classified as an employee, the IRS receives both the employer and employee portion of payroll taxes directly through the payroll tax withholding system. Their concern is that many businesses classify workers as independent contractors when they're actually employees. But before we get into classification of employees for employment tax purposes, I want to address your question about compliance checks.

The IRS's stated purpose for compliance checks is to educate taxpayers and encourage compliance. Compliance checks are clearly different from examinations or audits since the IRS isn't trying to establish tax liability. When they initially contacted you regarding the check, the IRS should have told you this wouldn't be an audit and that they'd be limiting the scope of their check only to IRS documents. If you've been contacted for a compliance check, you should probably let your accountant-and if appropriate, your attorney-know.

During a compliance check, the IRS shouldn't be examining your books and records; rather they should be reviewing only IRS documents. Additionally, they shouldn't ask how you determined whether a W-2 or 1099 should be filed. To learn more about compliance checks, go to the IRS Web site and search the term "compliance check."

The compliance check has proved to be a valuable IRS tool for rooting out misclassified workers. During a compliance check, cooperate with the agent, but be precise in responding to his or her requests. Keep in mind that the IRS's Employment Tax Handbook states that "the examiner generally should be able to secure the information in one or two contacts with the taxpayer. If more than two contacts are necessary, an examination should be opened." The last thing you want to do is trigger a full-fledged IRS audit with uncooperative behavior.

Laura A. Collins is a CPA and freelance writer with more than 18 years' experience in finance and taxation. She writes from her home in Greensboro, North Carolina.


The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.

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