Lessons from the AICPA Tax Conference: #1 State Unemployment Tax Audits are the Doorway to Hell

Last week I attended the AICPA Conference on Tax Strategies for the High-Income Individual.  I came back with a number of things to consider and think about which I will share over the next few weeks.

One lesson was from the speaker on State Business Tax Issues, Mark S. Klein, Esq. (mklein@hodgsonruss.com) of HodgsonRuss LLP, (http://www.hodgsonruss.com/).

Unemployment insurance taxes are dealt with on the state level.  The unemployment pools really need money now so the states are getting aggressive.  The actual real dollars of tax is the umemployment tax rate times the first $7,000 or so of wages (states vary a bit).  The state auditors are looking for "independent contractors" who should be "employees."

So the auditor walks in and finds ten independent contractors he or she feels should be considered employees.  In the end the tax and interest, etc. totals $3,600.  The owner figures for such a small amount, why bother my CPA or lawyer, signs the consent for assessment and writes the check figuring its all finished.

"Silly Rabbit, Trix are for kids."  One could only wish.  The problem is state agencies share information with all sorts of people, like other state agencies and along with those agencies the various departments of the federal government. 

So the next visit comes from the state income tax division.  That person says I have a report that you have some "employees" you did not report state withholding for and that those withholdings (or having  the state equivalent to the W-4), is mandatory. The penalty is the amount of tax. 

"Let's see, ten times, say $40,000 each is $400,000, times 7% (the range could be zero to 8%), which comes to $28,000 plus some interest for a total of $33,000.  Opps, you had them for three years so let's call it an even $100,000.  But, if you can prove those individuals paid state income tax on that income, (like a copy of their tax returns), we will adjust the amount due.  After all the state doesn't want to collect taxes twice on the same income."

So after hours upon hours of time spent by the owner or his HR person getting things together, the state settles for a net $20,000, (the people who had left), and he next person to show up is from the Internal Revenue Service.  Without considering the income withholdings, the fifteen percent FICA and Medicare is going to run $60,000 a year on the $400,000 of wages.  Oh, and the relief provisions will not apply since they have a copy of your consent that admits you had employees.  With the interest and penalties, let's just say $200,000.

Welcome to Hell.

A knowledgeable CPA or attorney with experience in this area can help one take steps to limit the exposure to additional taxes and the penalties and interest that follow.  So when the notice comes, call before signing the consent.

Dave
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