Bear in mind: Private letter rulings (PLRs) only apply to the companies seeking them. But they do give you an idea of how IRS looks at certain issues.

In this case, employees sued the company for unpaid leave and vacation time. As part of the settlement, the court ordered the company to pay attorney’s fees for the employees in the suit. According to the PLR, the awarding of attorney’s fees is essentially a reimbursement of an expense. Therefore, it’s not subject to taxes or reporting.

You can the download the PLR here to see all the details.

IRS has warned its going to start doing random employment tax audits in 2010. It’s aim: To find out exactly how much tax revenue the feds are losing due to employees being misclassified as independent contractors (ICs).

IC classification has always been a gray area — which is why many companies have relied on making an educated guess and then knocking on wood. Without any other red flags, many potentially misclassified employees (and their employers) have flown under the radar.

Random audits could be done at any company — there’s no way to minimize your risk of getting flagged.

What you can do: Go through your hiring procedures now and review the work done by ICs. The first random audits won’t be done until around April 2010, so there’s still time to address any questionable classifications you have on your books.

The company treated its salespeople as ICs because the workers set their own hours, had no set territory and didn’t have to report back to the company on how or where they spent their time. The workers weren’t required  to provide written reports on their work, although some did so voluntarily.

Sounds as if the workers had control, right? But the court found that they were employees, in part because of the amount of support the company gave them. The company reimbursed the sales force for business expenses ranging from gas and hotels to advertising costs and photocopying. It also provided company-owned vehicles the salespeople used.

Because the salespeople had no ownership stake or personal investment in the tools and equipment used to perform their work, they were employees.

The company is currently fighting the assessment, arguing that, at minimum, it qualifies for Sec. 530 relief — for having made a good-faith effort to correctly classify the workers.

We’ll keep you posted as the case develops.

The “Employee Misclassification Prevention Act” (S. 364B) would amend the FLSA to clarify that misclassifying employees as independent contractors is a prohibited act. The bill would also call for civil penalties of up to $10,000 as well as liquidated damages for the employees who were affected.  

If the bill passes, your company will be required to formally notify workers of their status as ICs, and keep records pertaining to the classification and the workers’ employment.

A related bill, H.R. 6111, has been introduced in the House.

Note: The Senate version is co-sponsored by President-elect Obama, so not only is it likely to pass a Democratic-controlled Congress, there’s also no doubt he’ll sign it into law.

FedEx is learning an expensive lesson. Several years ago, the company misclassified its drivers as independent contractors (ICs) instead of employees. The feds discovered the error — and the company’s been paying for it ever since.

In 2002, FedEx was ordered to pay the drivers (current and former) $5 million in business expenses. And in 2007, the federal government found the company owed $319 million in back employment taxes and penalties related to the error.

And it’s still not over: The California Superior Court has just ordered the company to pay another $9.1 million to the drivers for job-related expenses. Similar cases are being heard in 40 other states.

Something to think about next time a hiring manager asks if its that big of a deal to just call someone an IC for convenience’s sake.

That’s what happened when Peno Trucking discovered that despite its best efforts, it had improperly misclassified several employees as independent contractors (ICs).

Peno applied for tax relief, and it was granted by the U.S. Tax Court for a few key reasons. The company had:

• a reasonable basis for classifying the workers as ICs
• consistently treated the workers as ICs
• filed all appropriate 1099s, and 
• otherwise lived by the letter of the tax law. 

As such, the mistake was seen as just that — a mistake, and not a deliberate tax dodge.

Note: If you’re faced with a problem like this, IRS has very specific requirements. Peno also pointed out that the Ohio Industrial Commission and the Board of Workers’ Compensation had both ruled that the workers were ICs. Although it accepted Peno’s other arguments, the court rejected that as a reason for relief because those organizations use different standards than IRS.

The hope is that people will then ‘fess up what they actually owe, and IRS can save itself the time and money of repeatedly contacting those who underreport, as well as avoid collections efforts for small-dollar amounts.

If it works, it could save A/P a lot of grief: ICs who underreport cost IRS billions each year in lost taxes. And if the “honor program” doesn’t put a big dent in that, you can expect IRS to look for different methods to collect that “lost” money. 

So far, the most “popular” plans to make up the so-called tax gap all involve more work on A/P’s end: More reporting, gathering more info on vendors, etc.

Sound off in the comments: Will this honor program save you from having to do more work? Or will IRS have to bring down the hammer — and shove its tax enforcement work onto you?

You won’t just be getting more info — you’ll have to send out more, too. With each 1099, you’ll be required to give ICs contact info for the Dept. of Labor. So, it’s that much easier for them to report your company for any mistakes — real or imagined — that a contractor thinks you might’ve made. 

(Let’s face it, even if you do everything by the book, an IRS audit is probably the last thing you need.)

Has your company ever mistakenly classified an employee as an IC (maybe you suspect that it did but it was never caught by the feds)? Penalties for that and related mistakes would also increase under this legislation. Under the bill, (H.R. 6111) your company could pay up to $10,000 per violation. 

There are several related bills pending in both the House and Senate, so it’s too early to say exactly which version (or combinations thereof) might end up as law. 

But with Congress and IRS both looking at increased IC enforcement as a good way to close the so-called Tax Gap, you can be sure some version of these bills will pass. And most likely, it’ll be sooner than you expect.

For example, in four months, a New York State task force initiated 17 investigations based on employee interviews. So far, $3 million in back taxes and penalties due to worker misclassification has been found.

And that’s just at the state level. Now that the errors have been exposed you can imagine what the federal tax hit will be.

And with that kind of “return on investment” there’s plenty of reason for auditors in all states to take a second look at this area of your tax compliance.

If the bill becomes law and IRS discovers you’ve misclassified someone, your company might have to pay damages to the employee (for missed benefits) and fines of up to $10,000.

With an estimated 10 million misclassified ICs out there, it’s not unthinkable that you have one or two on your books, especially if you work in certain industries, like construction, that are known to have chronic problems with classification.

To make sure your company’s not at risk, you might want to review the differences between ICs and employees with hiring managers. Key: Be sure they understand there are real penalties for confusing the two. This isn’t just about Accounting wanting to follow some esoteric procedure.

If your company has a lot of ICs who are former employees, or workers who have temporary or part-time schedules, consider reviewing their files too. Automatically classifying temps and former employees as ICs is a common mistake – if your company has done it, you’ll want to make the corrections sooner rather than later.