Relief From the IRS for Misclassified Workers

In Notice 2011-95 issued on September 21, 2011, the IRS announced a new voluntary compliance program focused on assisting employers in the proper classification of its workers. The new settlement program provides a hugh financial relief for those employers who have improperly classified certain workers as independent contractors that should be classified as employees.

The Issue

It is all too common that employers classify workers as independent contractors that should be treated as employees. There are many reasons this occurs, but some of the most common that I hear include:

• The employer is just hiring the worker on a trial basis


• The worker is only going to be working on an infrequent basis


• The worker is only going to be working on a one time occurence


• The worker is going to be paid a flat fee


• The worker wants to be treated as an independent contractor


• It is too expensive to treat a worker as an employee

Unfortunately none of the above excuses are valid. Relying on such excuses, an employer can end up in the expensive situation of having to pay back payroll taxes when the IRS or a state authority steps into the picture. Even voluntarily correction of a workers classification can be so expensive the an employer prefers to continue on an incorrect path rather than make the necessary corrections.

IRS Provides An Out

The new program announced by the IRS will allow an employer to properly classify a worker as an employee on a prospective basis for a very small payment. Employers are eligible to enter the compliance program if they:

• Consistently have treated the workers in the past as nonemployees;


• Have filed all required Forms 1099 for the workers for the previous three years;


• Are not currently under audit by the IRS; and


• Are not currenlty under audit by the Department of Labor or a state agency.

An employer can apply for the program by filing Form 8952 at least 60 days before they want to begin treating the workers as employees. For example, if an employer would like to begin treating certain workers as employees as of the beginning of 2012, then it must file the Form 8952 by November 2, 2011.

The form includes a calculation that assesses the amount due on the reclassification. The amount is based on the wages paid during the most recently completed tax year and it is the equivalent of approximately 1.3% of the wages paid. This is a substantial savings over the options that exist outside of this program.

Application of Program for Churches and Other Nonprofit Organizations

One of the greatest liabilities for a church or a nonprofit is errors in the area of payroll. While not all of them center around worker classification, it is one of the most common errors. Churches and nonprofits often make incorrect decisions in this area due to relying on what another church/nonprofit or by relying on what they believe should be the correct classification. The fact is that the definition of an employee is very broad and encompassses most workers in nonprofits other than outside consultants or workers that are clearly operating a business that is available to general public. Some of the most common workers that are misclassified include:

• Nursery workers


• Musicians


• Maintenance workers


• Other workers that work either part time or on an irregular schedule

Action Required

This program is a definite consideration for all churches/organizations that have a worker classification issue. All organizations should take the time to review the workers currently classified as independent contractors to determine if that classification is correct. It may be necessary to engage a professional to assist with the proper classification of a worker. If this review discloses workers that should be classified as employees, then an organization should consider filing Form 8952 to take advantage of this program. Employers that are accepted into this program will not be audited on payroll taxes related to these workers for prior years. Participating employers will, for the first three years under the program, be subject to a special 6 year statute of limitations, rather than the usual three years than generally applies to payroll taxes.

IRS Offers Relief For Cell Phones

Previously I posted the update regarding the change in cell phone classification in regards to the strict documentation procedures that had been required to justify business use of the cell phone. However, despite the relief given, we were still a little in the dark about the position of the IRS in regards to employer provided cell phones and employer reimbursements for the use of personal cell phones.

The Guidance
Recently the IRS issued Notice 2011-72 granting an early Christmas present to all of us. The notice walks through the same analysis as offered in my previous blog, but it goes one step further. In the notice, the IRS stated that if an employer can determine that it has a bona fide business reason for issuing an employee a cell phone and the cell phone is not considered to be compensation for the employee's services, then it will deem that all the documentation standards of IRC Sec. 132 to qualify the benefit as a "working condition" fringe benefit will have been met and any personal use will be deemed to be a "de minimis" fringe benefit.

While the above notice does not address reimbursements to an employee for the use of their personal cell phone, the IRS issued a memorandum to their field examiners on Septemeber 14, 2011 extending similar logic to reimbursements. The example provided in the guidance allowed the tax free reimbursement of an employee's flat rate plan where the employer deemed that there was a business reason for the employee to have a cell phone.

The Gift
Having documentation "deemed" to be met is the gift from the IRS. Normally, a business would have to maintain documentation to show that the business useage was the predominant use of the phone. With this documentation burden relieved, the employer must only document the business reasons why an employee is required to have the phone. Providing the phone as a part of the employee's compensation package will disqualify this as a tax free benefit. Therefore, I recommend that it not be included in the employee's employment offer as a part of his package.

The Action
Since we are now down to one documentation step, I urge you to not skip this step. When documenting the arrangement with the employee, fully state why it is important that an employee have the cell phone. One word of caution, if the reason is so that the employer can communicate with that employee at any time, you could create a wage and hour issue with nonexempt employees. Remember, if you put them on call, you may have to pay them.

Consequences of Participant Designated Accounts

One subject that continually makes its way into practically every speech I deliver has to do with the tax consequences of maintaining participant designated accounts for fundraising activities. I have been speaking about this particular subject for approximately 4 years as the IRS has continued to get more and more serious about the ramifications of maintaining these types of accounts.

Possible Scenario:

Youth group needs money to help pay for camp fees for the students. A local advertiser tells the church that they will pay the church a set amount, if the students will go to a local stadium and place flyers in all the stadium seats prior to the big game on Sunday. The youth minister tells the kids that the funds paid to the church will be designated to the students' camp fees according to how long they assist in putting out the flyers.

Potential Consequences:

Payroll - The students have now been paid for their help in putting out the flyers. Therefore, they have been paid for their personal services. This has been done under the direction of the church staff. Therefore, all the students who have money credited to their camp fees have been compensated for their services and have been turned into employees of the church. Now the church is required to have all of the employment forms completed on the students and pay all the related payroll taxes. This was the result a few years ago with two booster clubs in Kentucky. See the story at http://www.kentucky.com/211/story/485490.html.

Tax Exemption - The IRS has ruled that this type of activity is private benefit to the students. Substantial private benefit to individuals can jeopardize an organizations exempt status. This was the conclusion in PLR 201035034 issued by the IRS last year. In the letter ruling, the IRS revoked the tax exempt status of a booster club due to the fact that practically all of their activities were performed to generate funds directed into participant accounts.

Income Tax - While not automatic, many fundraising activities do not generate unrelated business income due to the exception provided for activities conducted by volunteers. If all the volunteers have been turned into paid employees, this exception is no longer available. Therefore, it is possible that the activity will generate unrelated business income and subject the organization to filing Form 990-T.

Just How Serious????

Responses to this topic have varied from incredulous to skeptical to dismay. With the issuance of the above private letter ruling, it was obvious the IRS was beginning to take this issue to a more public level. Earlier this year I was informed that exempt organization agents were being trained in this specific issue.

On June 27, 2011, the Director of Exempt Organizations, Lois Lerner, issued a directive to the Director of Examinations and the Director of Rulings & Agreements. The directive clearly states that such programs are considered to be private benefit and could result in an organization losing its exempt status and the amounts credited to a participant's account could result in employment taxes. With this directive, the issue will be considered one for review for organizations that are undergoing examinations and/or that are requesting rulings as to their tax exempt status.

Conclusion

While these types of fundraising programs still can provide additional funds for a church, school or other type of organization, the distribution of the funds cannot be connected with the work performed by the person. The funds must be used for the general purposes of the organization or to provide for a reduced cost of an activity for all involved, working or not.

The List Is Out

Background
In 2006 Congress passed the law that automatically revoked the tax exempt status of any organization that failed to fulfill its Form 990 filing requirement for 3 years in a row. 2010 brought the first year this would be possible since the passing of the law with those who failed to file anything for the years 2007, 2008 & 2009. While the revocation date was effective for calendar year returns on May 17, 2010, the IRS continued to show some grace by allowing organizations to file through a special program conducted through October 15, 2010.

Results
With that program at its end and the final time passing to file most of the returns for the 2009 year, the IRS has finally issued the dreaded list of revocations. The list contains the names of approximately 275,000 organizations and can be found at www.irs.gov/autorevocationlist. It is organized by state. (Strangely enough the revocations for Texas is so large that it takes two files to cover it.)

What To Do
The law is clear - there is no disputing the revocation with the IRS or challenging it through the courts. IRS Notice 2011-44 details the process for reinstatement of tax exempt status. Organizations on the list are required to file new exemption applications, either Form 1023 or Form 1024, to request the exempt status be reinstated. Both the exemption application and the envelope should clearly indicate "Automatically Revoked" in order for the application to be directed to correct processing area.

Reinstatement will be effective the filing date of the exemption application unless the organization can provide reasonable cause for the failure to file Forms 990 all those years and provides the Forms 990 for 2007, 2008, 2009 and 2010. If the organization would have been eligible to file Form 990-N during all of the three missed year, then special procedures have been described to allow for a lower user fee to be paid with the application and they will gain retroactive exempt status. Procedures describing these special provisions can be found in IRS Notice 2011-43.

There will be many questions as organizations scramble to try to regain tax exempt status. The IRS has addressed many of those in its frequently asked questions found at http://www.irs.gov/charities/article/0,,id=221600,00.html. If an organization has received its notice of revocation or it is listed on the published list, it should seek the counsel of a CPA experienced in preparation of Forms 990 as well as experienced in the preparation of Forms 1023/1024.

Housing Allowance for Vacation Homes

In a remarkable decision by the full Tax Court, the Court has ruled that Phil Driscoll should be allowed to utilize the housing allowance provisions under IRC Sec. 107 for both his primary residence and his lake home. Utilizing a technical provision in the law, the Court has agreed that the term "a home" should not be interpreted as purely singular in nature, but should also apply in the plural. The result is that the housing allowance utilized to provide the Driscoll's lake home is excluded from their income. Writing the dissenting opinion, Judge Gustafson noted that there was insufficient evidence to state that Congress intended multiple homes to be covered under this provision. Additionally, he points out that the court's job is to narrowly construe the exclusions from income and not to throw open the door to excluding expenses for two, three, or four homes. These are valid points and will more than likely be the basis for an appeal by the IRS. What does this mean for ministers today? A Tax Court decision is binding on the IRS. Therefore, at this moment, it is the law in regards to this provision. However, it is more than likely that the IRS will appeal this ruling. It is not one that they can easily agree to. In the event that the appeal rules in favor of the IRS, then it will be as if this current case was never law. However, in the event the IRS does not appeal or loses the appeal, this case stands as binding on the IRS. It seems that "caution" would be the best watch word for the day. However, there are some actions that ministers should take today to capture this tax benefit in the event the case is allowed to stand. Ministers should consider the following actions: For 2011: Preparing for the Future

• Housing allowance cannot be changed at the end of the year, so ministers with current second homes should consider increasing their housing allowance for 2011 to cover the expenses of the second home. If the decision of the Tax Court is not reversed by an appellant court, it would be too late to fully benefit from this change in the law at the end of a tax year.

For 2010: To Claim or Not To Claim

Ministers with excess housing allowance for 2010 should consider if they are ready to follow this ruling and claim expenses on a second home for 2010. This is a serious decision that should be fully explored with a tax professional. There are two viable options to be considered:

• Use the expenses associated with the second home to determine the amount of housing allowance to be excluded from income and do not report any excess housing allowance on the 2010 Form 1040. This is an acceptable provision under current law. However, in the event the case is overturned on appeal, the IRS will have the ability to adjust the Form 1040 and assess all related taxes, penalties, and interest associated with the tax savings from this particular provision. Depending on the amount of the tax involved, ministers taking this route may wish to invest the additional taxes saved in order to preserve the funds in the event of a reversal.


• Do not use the expenses associated with the second residence to determine the amount excluded from income and file as would be normal. As a second step, the minister may file a protective refund claim stating that they are due a refund based on this particular case. If the Driscoll case is on appeal, the IRS will more than likely hold the refund claim until a decision has been issued by the appellant court. This will take an estimated 2 to 3 years.

As previously stated, these are very serious decisions to consider and require an understanding of the ramifications of each decision. However, with the assistance of a tax professional, a minister should be able to make a decision that aligns both with the law and with his/her risk tolerance level.

Driscoll v. Commissioner of Internal Revenue, 135 T.C. No. 27.