Our Taxing Times

Voluntary Worker Re-Classification

As part of the Fresh Start Program, the IRS has announced the new Voluntary Worker Classification Settlement Program (VWCSP). The program is to help employers who have mistakenly treated their employees as independent contractors to easily re-classify them and make a minimal back payment to cover the Social Security and Medicare contributions which were not made.

Employee mis-classification is a major issue for the IRS. Too many employers have treated employees as independent contractors out of mis-understanding of the rules or in a definite attempt to save money and paperwork. For the IRS, the key is control and I covered the topic in my post, Employee or Independent Contractor. The VWCSP will allow the employer to start correctly classify their employees and avoid a possible employment audit. An employment audit could result in considerably higher repayments for any year audited.

To be eligible the business, tax-exempt entities and government entities must have been treating their employees (or a group of employees) as independent contractors and want to correctly treat them as employees. Next, for the last 3 years, the employer has properly filed all required Forms 1099 for the workers. Finally, they can’t be currently under an employee classification audit by the IRS, Dept of Labor or their state agency. Application is made by completing Form 8952 and that must be submitted at least 60 days before the employer intends to make the change from contractor to employee.

If they are accepted into the program, the employer will pay an amount that is about 10% of the estimated taxes that would have been paid on the wages they actually paid in the preceding full tax year. Confusing, yeah! Here is the example from the VWCSP FAQ.

An employer decides to stop classifying their employees as independent contractors beginning January 1, 2012 and files their Form 8952 on October 1, 2011 and is accepted into the program. Their 2010, the last full tax year, contract labor was $1.5 million and based on the IRS’s section 3509 rules the effective tax rate is 10.68% for 2010 (if no employee earned more than the SS base rate of $106,800). The tax under this calculation is $252,000 and under an employment audit this is what they could expect to pay. However, they would only have to pay $25, 200 as part of VWCSP.

On top on only having to pay 10% of one year, the employer will not have to pay any interest or penalty on the tax and they won’t be audited for payroll taxes for any prior years. The only concession the employer has to make is to agree to a six year statute of limitations for the first 3 years they are under the program. The statute of limitations is usually just 3 years.

It will be interesting to see how many employers make the change. If they do, this is a great deal they should consider. For more info, please check the VWCSP page where you can find links to Form 8952 and Announcement 2011-64. If you are already under audit for mis-classification of employees, you might want to check out the Classification Settlement Program.

Tax-Exempt-Does It Mean What You Think It Does?

One of my favorite books and movies is “The Princess Bride.” There is a point when Princess Buttercup’s kidnappers realize that they are being followed that the group’s leader, Vizzini, yells “Inconceivable.” This becomes his response every time he is told that their pursuer is catching up with them. At one point Inigo Montoya, one of the kidnappers says of Vizzini’s use of “inconceivable” –“You keep using that word! I don’t think it means what you think it does.” The same can be the said of the phrases “tax exempt” and “non-profit.”

(I don’t want to get into too much detail. I could write a blog just on non-profits because of the complexity. I want to give readers enough info to get them thinking and researching.)

I want to specifically deal with tax exempt organizations because that is where I see the biggest problem. I talk to people all the time who are involved with a group they refer to as non-profit or tax exempt. They think by saying they are tax exempt means they don’t have to pay taxes. And if they don’t have to pay taxes they don’t have to file a tax return, right. No, that’s not right. A non-profit organization may still have certain taxes to report and pay. And even if they don’t have to pay Federal tax, they will have to file a return.

Let’s start with what is a tax-exempt organization (for IRS purposes)? It is usually a corporation (but it could be a trust or association) whose purpose meets very specific requirements outlined in IRS section 501(c). These entities are organized for charitable, civic/social welfare, labor/agriculture, business/profession, or social clubs. Most churches are also tax exempt but that is a whole separate post.  While each group has a list of requirements to be met, the theory behind them is that they are designed to provide a benefit to part of the general public not to make a profit. If the organization meets these requirements, they do not pay federal income taxes on profits from the income of their main operation. But they do pay taxes.

Having tax exempt status does not mean you don’t pay taxes. The organization could still be subject to property taxes, sales tax on their sales, and payroll taxes for employees. And they could be subject to UBIT. Yes, even a tax exempt organization could pay federal taxes on some of their income because of unrelated business income. A quick example is in order. Bobville Community Theatre (BCT) is a valid 501 (c)(3). They pay property tax on the theatre and sales tax on the income from ticket sales and dues. And they match the Social Security and Medicare for their employee. In order to raise money, BCT creates a gift shop where they sell logo merchandise, memorabilia and treats to their patrons. The income from the gift shop is unrelated business income. It has nothing to do with why they have tax exempt status. That is why their tickets sales, dues and donations are not taxable. The gift shop isn’t part of their exempt purpose and if the income is over $1000, BCT must report it and pay taxes on it.

That brings us to the next big misconception – which is a tax exempt organization does not need to file a return. This was changed a few years ago and all organizations need to file one of the 990 series. Which one(s) depends on the amount of income they receive, if they have UBIT and several other factors.  If the organization doesn’t file for 3 years, they are in danger of losing their tax exempt status. (Other posts- here and here

The only way to get tax exempt (non-profit) status is to apply through the IRS. The application may depend on the specific tax section you believe your organization falls under. But no matter which code section you think applies, you will have to provide lots of documentation. (And marking that you are a non-profit corporation on your state’s Secretary of State registration application does not make you a real non-profit and tax exempt.)

Look, there are a lot of meaning for the phrases non-profit and tax exempt. It depends on specific circumstances to know how taxes need to be handled. The biggest mistake a business can make is assuming that they are interchangeable. They aren’t. If you have some form of tax exempt status, make sure you understand exactly what limitations it has.

(FYI- of all the Federal tax exempt sections, only organizations which qualify for 501(c)(3) status (charitable) entitles a donor to a tax deduction in their tax return. But that's another post.)

Tax Exempts- Are You on the List?

Years ago, Congress changed the rules and started requiring annual reporting for tax exempt organizations. For most, this is just an informational return done on line. But if a return isn't filed for 3 years, the organization risks losing it's tax exempt status. I covered this in a May post.

The IRS has just released a list of tax exempt organizations which are now on the short list to lose their status. (Short? Kansas has over 3700, California has over 35,000 and Illinois has over 15,000 just to name a few) The IRS is giving the organizations more time to catch up before it starts starts pulling their tax exempt status. So if you are on the list, fix this now. Reinstatement is not fun. Fixing the issue is easier.