The Internal Revenue Service (IRS) launched a three-year, random employment tax audit initiative of up to 6,000 companies large and small, focusing on worker classification, payroll tax practices/reporting, fringe benefits and executive compensation.

The IRS will use this information as part of its National Research Program to set priorities for compliance within these areas, Washington, D.C.-based law firm Patton Boggs reported.

The IRS estimates that improved employment tax compliance will result in $7 billion in increased federal tax revenue over the next 10 years. Moreover, the worker classification issues will have an impact beyond just federal taxes. For example, if an independent contractor is determined to be an employee, the employer may be liable for social security and Medicare taxes, workers’ compensation, unemployment compensation, health insurance and overtime pay.

Proactively identifying and correcting any errors or discrepancies in employment tax related areas could significantly minimize a company’s federal and state exposure to penalties, according to Patton Boggs. In the worker classification area, it could also reduce a company’s liability for overtime to those found to be employees instead of independent contractors.

Patton Boggs suggested employers should review their:

1. current worker classification practices (employee vs. independent contractor);
2. current payroll tax practices (including backup withholding and W-2/1099 reporting);
3. fringe benefit (taxable and nontaxable) reporting;
4. expense reimbursement policies; and
5. executive compensation. Executive compensation issues expected to be targeted by the IRS include “reasonableness” of amount and compliance with Internal Revenue Code sections 409A (deferred compensation restrictions and penalties), 280G (golden parachute penalties) and 162(m) (performance-based compensation and deductibility limits).