4.23.5. Technical Guidelines for Employment Tax Issues

(1) The Internal Revenue Service (IRS) administers the employment taxes imposed by Chapters 21 through 25 of the Internal Revenue Code (IRC) and the self-employment taxes imposed by Chapter 2. An important phase of administration of employment taxes, including the self-employment tax, is interpreting the sections of the IRC applicable to these taxes, that is, issuing rulings and technical advice that clarify the intent of these sections. The IRS refers questions relating to:

1. Eligibility for and computation of social security benefits to the Social Security Administration, Baltimore, Maryland, or to their nearest local field office.

2. Unemployment benefits to the appropriate State Unemployment Compensation Board.

3. Railroad employee retirement benefits to the Railroad Retirement Board, Chicago, Illinois.

(2) In carrying out these duties, the IRS shares with these agencies a joint responsibility for administering the tax aspects of these programs. This requires close coordination between the IRS and these agencies at the national level to assure uniform interpretation and application of the various provisions of the law.

(3) Revenue Agents (RA), Revenue Officer Examiners (ROE), Tax Compliance Officers (TCO), Tax Specialists, and Indian Tribal Government (ITG) specialists make determinations with regard to tax liabilities for Railroad Retirement Tax Act (RRTA), Federal Insurance Compensation Act (FICA), Federal Unemployment Tax Act, (FUTA), and federal income tax withholding (FITW). Three conditions must be present for a tax liability for employee wages:

1. The relationship of employer-employee must exist.

2. The remuneration paid by the employer must constitute "wages" for purposes of the tax.

3. The employee must perform services that constitute "employment" as defined by the respective IRC Adopted the reviewer's recommendation..

(1) Employment tax provisions are found at IRC Subtitle C:

• Chapter 21, Federal Insurance Contributions Act (FICA),

• Chapter 22, Railroad Retirement Tax Act (RRTA),

• Chapter 23, Federal Unemployment Tax Act (FUTA),

• Chapter 24, Federal Income Tax Withholding (FITW), and

• Chapter 25, General Provisions relating to employment taxes and collection of income taxes at source.

(2) The Employment Tax Program is governed by Policy Statements and other internal guidance that apply to all IRS personnel regardless of operating division. The Policy Statements found in IRM 1.2.1, Servicewide Policies and Authorities, Servicewide Policy Statements, apply to all employment tax issues and examinations. Examiners should review these Policy Statements to properly perform their examination duties.

(3) A website, Search Servicewide Delegation Orders, located at https://irm.web.irs.gov/imd/del/search.aspx provides a searchable list of Servicewide Delegation Orders issued by the Commissioner of the Internal Revenue, or on their behalf by either of the deputy commissioners. Delegation Orders pertaining to each IRS business process can be found in IRM 1.2.2 , Servicewide Policies and Authorities, Servicewide Delegations of Authority.

(4) IRM 4.23 provides Servicewide instructions for all operating divisions with employees involved with the correct filing, reporting, and payment of employment taxes. IRM 4.23 serves as the foundation for consistent administration of employment taxes by various IRS operating divisions. By providing one source of authority for all operating divisions, the IRS greatly reduces philosophical and procedural inconsistencies.

(1) Director, Specialty Examination Policy, is responsible for the procedures and updates addressed in this IRM.

(2) Director, Examination Specialty Tax, is responsible for examination operational compliance.

(3) Chief, Employment Tax, is responsible for ensuring examiners follow the guidance included in this IRM.

(1) Program Goals: The processes and procedures provided in this IRM are consistent with the objectives or goals for Employment Tax - Examination that are addressed in IRM 1.1.16.5.3.3, Employment Tax Examination, and for Employment Tax Policy, found in IRM 1.1.16.5.5.2.2, Employment Tax Policy.

(2) Program Effectiveness: Program goals are measured with Employment Tax Embedded Quality Performance Reports that monitor whether quality attributes are applied uniformly and consistently.

(3) Annual Review: Program Manager of Employment Tax Policy is responsible for reviewing the information in this IRM annually to ensure accuracy and promote consistent tax administration.

(1) The following table lists commonly used acronyms and their definitions:

(1) The following table lists the primary sources of guidance:

(2) Helpful information sources include:

• The SBSE Employment Tax Small Business Knowledge Base (main page) is located athttps://irsgov.sharepoint.com/sites/ETD-KMT-KB014.

• The Specialist Referral System home page: https://srs.web.irs.gov/.

• A list of SB/SE Employment Tax Policy Analysts, their contact information and program assignments, are found at: Employment Tax Policy Contacts.

• The IRS Whistleblower Program home page is located at https://irsgov.sharepoint.com/sites/WO.

(3) The Taxpayer Bill of Rights (TBOR) lists rights that already existed in the IRC, putting them in simple language and grouping them into 10 fundamental rights. Employees are responsible for being familiar with and acting in accord with taxpayer rights. See IRC 7803(a)(3) . For additional information about the TBOR, see www.irs.gov/taxpayer-bill-of-rights or https://irsgov.sharepoint.com/sites/IRSSource/SitePages/Taxpayer-Bill-of-Rights.aspx.

(4) The Taxpayer Advocate Service (TAS) is an independent organization within the IRS, led by the National Taxpayer Advocate. Its job is to protect taxpayers’ rights by striving to ensure that every taxpayer is treated fairly and knows and understands their rights under the TBOR. TAS offers free help to taxpayers, including when taxpayers face financial difficulties due to an IRS problem, when they are unable to resolve tax problems they have not been able to resolve on their own, or when they need assistance to address an IRS system, process, or procedure that is not functioning as it should. TAS has at least one taxpayer advocate office located in every state, the District of Columbia, and Puerto Rico.

(5) Examiners will consider the disclosure and privacy provisions when preparing agreed and unagreed case reports. For further information, see the Privacy, Government Liaison and Disclosure (PGLD) maintained knowledge base at https://irsgov.sharepoint.com/sites/ETD-KMT-KB003.

(1) Generally, employment tax examination issues are divided into "wage issues" or "worker classification issues." The proper identification of the type of issue is essential for determining the examination procedures and the tax rates applicable to the issue.

(2) For all worker classification issues, examiners must determine whether:

1. The taxpayer has met the requirements of section 530,

2. IRC 3509 rates will be used to compute the tax adjustment,

3. The taxpayer is eligible for a Classification Settlement Program (CSP) offer.

(3) For all wage issues:

1. Section 530 relief is not applicable,

2. IRC 3509 rates are not applicable, and

3. CSP is not applicable.

(4) Wage Issues: Generally, when a taxpayer treated workers as employees by issuing Forms W-2, Wage and Tax Statement, for wages, and the issues being examined are considered to be additional compensation that should have been reported as wages, the issue is classified as a "wage issue." Examples of wage issues include:

1. Payments under a non-accountable plan,

2. Compensation paid to employees in property (for example, stock, stock options),

3. Payment of non-qualified deferred compensation,

4. Severance payments to former employees, and

5. Fringe benefits not excludable by a specific IRC section or that fail to meet the statutory requirements for exclusion from wages.

(5) Worker Classification Issues: Generally, when a taxpayer did not treat workers as employees, the examination of whether the payments are subject to employment taxes is considered a worker classification issue, i.e., the payments are subject to employment taxes if the examiner determines that the workers should have been treated as employees. If the taxpayer failed to issue a Form W-2 to the worker and only issued a Form 1099-MISC, Miscellaneous Income, Form 1099-NEC, Nonemployee Compensation, (or any other form in the family of Forms 1099 - see Caution below), the issue is generally considered a worker classification issue. However, when the worker received both a Form W-2 and Form 1099-MISC and/or Form 1099-NEC in the same calendar year, determining whether the issue is a worker classification issue is based on the facts of the particular case.

(1) "IRC 7436 issues" is an "umbrella" term that includes:

1. Worker classification: Whether a worker is an employee.

2. Section 530: Whether a taxpayer is entitled to section 530 relief.

3. Wage issues subject to IRC 7436: Where a taxpayer raises either a worker classification or a section 530 argument with respect to a wage issue.

(2) The issue for Tax Court jurisdiction is not whether there is a reclassification of workers, but whether there is an "actual controversy" involving a worker classification or a section 530 determination.

(3) Worker classification issues are always IRC 7436 issues.

(4) Some wage issues will be IRC 7436 issues and some will not. Wage issues are IRC 7436 issues if:

1. The payment was reported on Form 1099,

2. The taxpayer raises worker classification arguments with regard to the wage issue, or

3. The taxpayer raises section 530 arguments with regard to the wage issue.

(5) The following situations illustrate when an employment tax issue falls under IRC 7436:

1. When Form 1099-MISC or Form 1099-NEC is issued and an employment tax adjustment is proposed for the payment on, the issue will fall under IRC 7436 regardless of whether worker also received Form W-2 in the audit year and regardless of the purpose of the payment reported on the Form 1099-MISC or Form-1099 NEC. The issuance of a Form-1099 MISC or Form 1099-NEC for the payment is an implicit argument that the worker is not an employee with respect to the payments reported on the Form 1099-MISC or Form 1099-NEC, thus creating an "actual controversy" under IRC 7436.

2. Worker received Form W-2 for audit year and received additional payments not reported on any information return, but taxpayer raises a worker classification or section 530 argument for why the additional payments are not wages. The taxpayer’s argument creates an "actual controversy" under IRC 7436.

(6) The following situation demonstrates when an employment tax issue does not fall under IRC 7436:

(7) The following example demonstrates when an employment tax issue generally would be considered to fall under IRC 7436:

(8) An issue initially identified as a wage issue will usually not be considered to be an IRC 7436 issue at the beginning of the audit unless the payment was reported on Form 1099-MISC or Form 1099-NEC. Examiners will likely not identify a wage issue as an IRC 7436 issue until later in the examination as facts are developed and taxpayers present their positions on the issue by raising a worker classification or section 530 argument. Examiners will not raise a worker classification or section 530 argument with the taxpayer in a wage issue unless the taxpayer brings it up during the audit. If the issue is identified as a wage issue and the taxpayer did not report the payment on Form 1099-MISC or Form 1099-NEC, or raise a worker classification or section 530 argument with regard to the payments, then the issue will remain a wage issue not subject to IRC 7436.

(9) If the taxpayer fails to raise a worker classification or section 530 argument with respect to a wage issue during the audit but raises either of these issues in a protest to a 30-day letter, the issue will then be considered an IRC 7436 issue. Examiners must consider the taxpayers’ arguments and develop the issue further to address these arguments before sending the case to Appeals.

(10) Just because an issue falls under IRC 7436 does not mean it is a worker classification issue to which section 530, IRC 3509 rates, and CSP apply. If the issue is a wage issue that is subject to IRC 7436, examiners will need to address that section 530, IRC 3509, and CSP are not applicable.

(11) Backup withholding adjustments are generally not IRC 7436 issues. If a taxpayer raises a section 530 argument with respect to a proposed backup withholding adjustment, contact TEGEDC for guidance on whether to follow IRC 7436 procedures.

(12) Combined Annual Wage Reporting (CAWR) examinations address issues on cases in which the taxpayer filed Forms W-2 and withheld employment taxes but failed to file employment tax returns and pay the appropriate employment taxes. Generally, CAWR cases are not IRC 7436 issues. If a taxpayer raises a worker classification or section 530 argument with respect to a proposed CAWR adjustment, contact TEGEDC for guidance on whether to follow IRC 7436 procedures.

(13) When examiners encounter situations in which the taxpayer used a Professional Employer Organization (PEO) or Certified Professional Employer Organization (CPEO) to pay wages to the employees, any employment tax adjustments assessed against the taxpayer may or may not be subject to IRC 7436 depending on the facts of the specific case. Examiners will contact TEGEDC for guidance on these cases to determine whether these are IRC 7436 issues.

(1) Section 530 is a relief provision that must be considered as the first step in any case involving worker classification. Relief is available to taxpayers that are under examination or involved in administrative (including Appeals) or judicial proceedings with respect to assessments or proposed assessments based on employment status reclassification.

(2) Section 530 applies only to worker classification issues. Section 530 does not apply to wage issues. However, if a wage issue is determined to be an IRC 7436 issue, the examiner must address section 530. See IRM 4.23.5.2.2, IRC 7436 Issues, for guidance on when a wage issue is subject to IRC 7436. Also, refer to IRM 4.23.5.3.2, Addressing Section 530 for IRC 7436 Wage Issues, for guidance on addressing section 530 for IRC 7436 wage issues.

(3) The taxpayer need not concede or agree to the determination that the workers are employees for section 530 relief to be available.

(4) The examiner must first explore the applicability of section 530 even if the taxpayer does not raise the issue. It is not necessary for the taxpayer to claim section 530 relief for it to be applicable.

(5) Pub 1976, Do You Qualify for Relief under Section 530?, must be provided to the taxpayer before initiating any worker classification or IRC 7436 wage issue examination.

1. This publication can be provided with the appointment letter or during the initial interview of an employment tax examination if a worker classification or IRC 7436 wage issue is identified during pre-exam or if worker classification is the reason for the examination.

   Note: The examiner may not know whether a wage issue is an IRC 7436 issue until later in the examination after the taxpayer raises either a worker classification or section 530 argument with respect to the issue. Publication 1976 will be provided to the taxpayer at the time the examiner determines that the wage issue is an IRC 7436 issue.

2. If a worker classification or IRC 7436 wage issue arises during the course of an income tax or tax-exempt examination, the publication must be provided at that time.

3. Notate how and to whom the publication was delivered in Form 9984, Examining Officer's Activity Record, in the case file.

(1) For wage issues that are subject to IRC 7436, section 530 needs to be addressed in two ways:

1. The examiner must explain in the workpapers that section 530 is not applicable because this is a wage issue, and

2. The examiner must also explain whether the statutory requirements for relief would have been met if section 530 were applicable to the issue.

(2) "Is Not Applicable": Section 530 only applies to worker classification issues and never applies to wage issues. Raising section 530 in regard to a wage issue creates the controversy that makes the issue fall under IRC 7436. However, section 530 is not applicable because it is still a wage issue.

(3) Although the examiner must explain the IRS’s position that section 530 applies only to worker classification issues, the examiner must still address the merits of section 530 as an alternative argument in case the Tax Court decides that section 530 is applicable to that wage issue.

(1) The taxpayer must meet two consistency requirements before the relief provisions of section 530 apply. The relief applies only if:

1. All federal tax returns, including information returns such as Form 1099-MISC or Form 1099-NEC required to be filed with respect to the worker for the period, are timely filed and filed on a basis consistent with the taxpayer’s treatment of the worker as not being an employee. See discussion at IRM 4.23.5.3.3.1, Consistency Requirement—Reporting Consistency, and

2. The treatment of the worker as not being an employee is consistent with the treatment by the taxpayer (or predecessor) of all workers holding substantially similar positions. See discussion at IRM 4.23.5.3.3.2, Consistency Requirement—Substantive Consistency.

(2) In addition to the consistency requirements, the taxpayer must have had a reasonable basis for not treating the worker as an employee. See discussion at IRM 4.23.5.3.3.3, Section 530 - Reasonable Basis, and following subsections.

(3) Examiners must address and develop all three requirements of section 530 even if the taxpayer fails one of them.

(4) The examiner should work with the taxpayer to determine what information is needed to decide whether the taxpayer has met the requirements for section 530 relief. Exercise caution to ensure requested information is both relevant and reasonable.

(5) Under the section 530(e)(4) "Burden of Proof" provision, the IRS will bear the burden of proving that the taxpayer’s treatment is inaccurate. The burden of proof does not shift to the IRS if the taxpayer relied on some other reasonable basis. A prima facie case means that the taxpayer has presented evidence that will allow the taxpayer to prevail unless the government presents other evidence that contradicts and overcomes the taxpayer’s evidence. The taxpayer establishes a prima facie case by meeting:

• The reporting consistency requirement,

• The substantive consistency requirement,

• One of the three reasonable basis safe havens, and

• The taxpayer has fully cooperated with reasonable requests from the examiner.

(6) If the examiner determines that the taxpayer is entitled to section 530 relief, the examination of the worker classification issue will be discontinued. The taxpayer will continue to file the required federal tax returns (such as Form 1099-MISC or Form 1099-NEC) with respect to the workers.

(7) Comments on Form 4318-ET, Employment Tax Examination Workpapers, Standard Audit Index Number (SAIN) lead sheet, "Section 530 Lead Sheet Worker Classification Issues," Form 5773, EP/EO Workpaper Summary Continuation Sheet, or other similar workpapers, will explain the basis for allowing or denying the relief. In unagreed cases, address the section 530 relief issue in the Employment Tax Examiner's Report (ETER) in the same manner as any other unagreed issue (issue, statement of facts, law, taxpayer position, and conclusion). See IRM 4.23.10.16.1, Preparing Explanation of Adjustments.

(1) Generally, a worker status determination for a class of worker is not made by an examiner if the firm is entitled to section 530 relief with respect to those workers. However, workers may be determined to be employees through some other means such as an employee plans examination. In addition, workers may request a determination of their individual status by filing a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. See IRM 4.23.3.3.3 , SS-8 Program, for additional information.

(2) It is important to remember that even if an employer is entitled to section 530 relief, workers determined to be employees in paragraph (1) are employees for other purposes of the IRC. Section 530 only terminates the liability of the employer for the employment taxes but has no effect on the employees’ status. It does not convert workers from the status of employee to the status of self-employed (non-employee). The workers are still considered employees for income tax and qualified benefit plan eligibility purposes. Therefore, the employer must consider these workers as employees in determining whether its pension, profit-sharing, or stock-bonus plan satisfies the qualification requirements of IRC 401(a).

(3) The workers determined to be employees in paragraph (1) remain liable for the employee share of FICA tax with respect to all wages received. See Rev. Proc. 85-18, section 3.08, and Treas. Reg. 31.3102-1(c). See also Rev. Rul. 86-111, 1986-2 C.B. 176.

(4) Where workers determined to be employees in paragraph (1) have filed and paid their tax under the Self-Employment Tax Contributions Act (SECA), they may file a claim for refund for the difference between SECA tax and the employee share of FICA, if applicable. However, they may owe additional tax if the employee share of FICA exceeds the SECA that they actually paid. The specific tax effect will depend on a number of factors, including the amount of expenses deducted on Schedule C (Form 1040), Profit or Loss From Business, (if any) and whether the expenses are allowable as a deduction on Schedule A (Form 1040), Itemized Deductions, as employee business expenses (for years prior to 2018).

(5) As an employee, the worker generally cannot deduct unreimbursed business expenses on Schedule C (Form 1040) but must deduct them as miscellaneous itemized deductions on Schedule A (Form 1040), subject to the two-percent limitation under IRC 67. This sometimes results in liability for the alternative minimum tax. Further, the worker cannot adopt or maintain a self-employment retirement plan. Finally, certain benefits provided by the taxpayer to a worker as an employee may be excludable from income by the employee due to specific IRC exclusions provided only to employees (for example employer provided accident and health insurance).

(6) Notice 989, Commonly Asked Questions When IRS Determines Your Work Status is "Employee", is mailed to taxpayers who submit a Form SS-8 to determine their exact employment tax status (i.e., employee or independent contractor), along with the appropriate SS-8 Determination Program Letter. The notice contains information for Form 1040, U.S. Individual Income Tax Return, filers if their status is changed from non-employee to employee.

(1) In an examination of an employer to determine worker status, the examiner may need to interview workers and question them with regard to the three categories of evidence used to determine a worker’s status for federal tax purposes. When this occurs, the examiner may use questions based on Form SS-8 to assist in the determination. However, the actual Form SS-8 is not to be used or provided to the workers or the employer.

(2) Additional questions may be required to be developed by the examiner for specialty job categories or to establish controlling factors known to be important in applicable rulings and/or court cases.

(3) Examiners are required to provide notice to a taxpayer prior to making any third-party contacts with respect to that taxpayer. Effective August 15, 2019, Pub 1, Your Rights as a Taxpayer, will no longer satisfy the advance notice requirement of IRC 7602(c)(1). Thus, in all cases involving third-party contact notices provided after August 15, 2019, or in which contacts with third parties will occur after August 15, 2019, a notice meeting the new requirements must be provided, and no contact with a third-party can be made until the 46th day following the date of the notice.

(4) General notice procedures now require employees to:

• Intend at the time notice is issued to contact persons other than the taxpayer,

• Issue advance notice of third-party contacts (see (5) following),

• Specify that the time period is not to exceed one year. However it may be re-issued at the end of the one-year time period for an additional one-year time period, and

• Wait 45 days before contacting a third-party.

(5) Notice is made by using Letter 3164-E, Third Party Contact, or other notice letter designated by the examiner’s organization. The notice must include the tax period(s) at issue and the time period, not to exceed one year, within which the IRS intends to make the contacts. If necessary, the notice may be reissued.

(6) Additional information is available at:

• IRM 25.27.1, Third Party Contact - Third Party Contact Program

• IRM 4.10.1, Overview of Examiner Responsibilities

• IRM 4.10.2, Pre-Contact Responsibilities

• IRM 4.23.3.6.6.1, Third-Party Contacts

• IRM 4.11.57, Examining Officers Guide - Third Party Contacts

(7) Document the case history/activity record with the date of mailing or personal delivery of the notice requirements in (3) above, as well as the date that Form 12175, Third Party Contact Report Form, was prepared and forwarded to the Third Party Contact Coordinator. See IRM 4.23.3.6.4, Scheduling the Initial Appointment, and IRM 4.23.3.6.5, Contact With Taxpayers, for additional requirements.

(1) To determine whether the control test is satisfied in a particular case, the facts and circumstances must be examined. Ask questions about the relationship between the worker and the taxpayer to ascertain control.

(2) The 20 factors listed in Rev. Rul. 87-41 may still be used for reference purposes, but the primary method is to consider every piece of information in a case that helps to decide the extent to which the taxpayer does or does not retain the right to control the worker. The evidence tends to fall into three main categories:

1. Behavioral control,

2. Financial control, and

3. Relationship of the parties.

(3) There are four important points to remember:

1. There is no "magic number" of relevant evidentiary factors.

2. Whatever the number of factors used, the factors merely point to facts to be used in evaluating the extent of the right to direct and control.

3. As in any examination, all relevant information needs to be explored before answering the legal question of whether the right to direct and control associated with an employment relationship exists.

4. The evidence the examiner gathers must be factual and well-documented. It must support the examiner's determination.

(4) The pieces of information that are important to help determine employee status change over time because business relationships change over time. What might have been a crucial piece of evidence in 1985 on which to base a decision about whether a taxpayer retained the right to control a worker may not carry the same weight for making an employee status determination currently.

(1) For FICA, FUTA, and FITW, the term "employee" includes any individual who, under the usual common law rules for determining the employer-employee relationship, has the status of an employee. Therefore, with certain exceptions, the imposition of employment taxes always involves the employer-employee relationship issue and requires the application of the common law rules to the specific facts and circumstances of each taxpayer. This application is the basis for determining the employment status of an individual worker or a group of workers.

(2) In a case requiring an employer-employee relationship determination, the examiner will compile information bearing on the three main categories of evidence. Evaluating such evidence will generally enable the examiner to resolve the employer-employee relationship question by applying law, regulations or a clearly applicable ruling.

(3) For treatment of special types of employment and special types of wage payments, refer to Pub 15, (Circular E) Employer's Tax Guide, for quick research on an issue. The IRC, regulations, revenue rulings, court decisions, and any other pertinent research are the best authority for any issues being proposed. Also, refer to Exhibit 4.23.5-2, Employment Tax Treatment for Various Categories of Workers for a quick reference regarding the tax treatment by the employer of FICA, FUTA, and FITW of wages earned by the various types of workers.

(4) If an employer-employee relationship exists, the designation or description of the parties as anything other than that of employer-employee is immaterial. Contractual designation of a worker as an independent contractor cannot outweigh evidence regarding the actual relationship between worker and taxpayer. Questions arising in employer-employee relationships which cannot be resolved by the examiner can be referred for technical advice, in accordance with IRM 4.23.15, Employment Tax - Technical Advice From the Office of Chief Counsel.

(1) Corporate officers are specifically included within the definition of an employee under FICA, FUTA, and FITW purposes. See IRC 3121(d)(1), IRC 3306(i), and IRC 3401(c). The common law standard is not applicable, as the regulations provide that an officer of a corporation is generally an employee of the corporation. However, Treas. Reg. 31.3121(d)-1(b) provided a narrow exception - an officer is not considered to be an employee of the corporation if two requirements are met:

1. The officer does not perform any services or performs only minor services, and

2. The officer is not entitled to receive, directly or indirectly, any remuneration.

(2) The officer must meet both requirements to be excepted from employee status. In determining whether services performed by a corporate officer are considered minor or nominal, examine:

• The character of the service,

• The frequency and duration of performance, and

• The actual or potential importance or necessity of the services in relation to the conduct of the corporation’s business.

(3) A director of a corporation, acting in the capacity of a director, is not an employee of the corporation for those services, even if that worker also serves as an employee or officer of the corporation for other services. Therefore, part of the compensation paid to this worker can be for services rendered as an independent contractor (director) and part of the payments can be for services rendered as an employee. Refer to Rev. Rul. 58–505, 1958–2 C.B. 728.

(4) Examine all payments to the officer, such as amounts labeled as draws, loans, dividends, or other distributions to determine whether the payments are potentially wages for FICA, FUTA, and FITW purposes. Refer to Rev. Rul. 74–44, 1974–1 C.B. 287.

(5) Examiners must address section 530 in all officer worker classification cases. Section 530 must be considered when there is a controversy involving whether individuals are employees. If a corporation treats an officer as an independent contractor and files Form 1099-MISC or Form 1099-NEC, the reporting consistency requirement of section 530(a)(1)(B) is met. Likewise, if the corporation pays distributions and provides Schedule K-1 (Form 1120-S), Shareholder's Share of Income, Deduction, Credits, etc., consistent with this treatment, then the reporting consistency requirement is met. Generally, the taxpayer will have difficulty satisfying the reasonable basis requirement of section 530 since officers who perform services for the corporation are employees by statute under IRC 3121(d)(1), 3306(i) and 3401(c).

(6) Officer worker classification compensation cases that involve whether certain payments are wages may be eligible for inclusion in the CSP. For additional information, and examples of the determination of reasonable compensation, see IRM 4.23.6.9, CSP and Officer Compensation Procedures.

(1) If a worker is not an employee as either a corporate officer or under the common law rules, the worker and the taxpayer may nevertheless still be subject to employment taxes. IRC 3121(d)(3) lists individuals in four occupational groups who, under certain circumstances, are considered employees for FICA tax and, in some instances, employees for FUTA tax, but not for FITW. These workers are referred to as statutory employees:

1. Agent-drivers or commission-drivers,

2. Full-time life insurance salespersons,

3. Home workers, and

4. Traveling or city salespersons.

(2) Workers in these four occupational groups are employees for FICA tax purposes even though they do not meet the common law test if they meet the general and specific requirements for each occupational group.

(3) To qualify as a statutory employee, a worker must first meet general requirements prescribed specifically for the category under which the worker is qualifying. Refer to Treas. Reg. 31.3121(d)–1(d)) and Exhibit 4.23.5-3, Statutory Employees.

(4) By definition, a worker cannot be a statutory employee under IRC 3121(d)(3) if that worker is a common law employee. See Ewens and Miller, Inc. v Commissioner, 117 T.C. 263 (2001). This conclusion is supported by the legislative history of IRC 3121(d). See S. Rep. No. 1669, 81st Cong., 2d. Sess. 144 (1950), 1950–2 C.B. 302, 346 - 348, and Lickiss v. Commissioner, T. C. Memo 1994–103.

(5) Statutory employees receive a Form W–2 with a check in Box 13, "Statutory Employee", indicating the status of statutory employee. Income tax is not withheld from statutory employees. As they are not employees for the purpose of deducting trade or business expenses they deduct their expenses on Schedule C (Form 1040) rather than as miscellaneous itemized deductions on Schedule A (form 1040) (for years prior to 2018). See Rev. Rul. 90–93, 1990–2 C.B. 33.

(6) If statutory employees also have earnings from self-employment, they may not use expenses from services as a statutory employee to reduce net earnings from self-employment for SECA proposes, because services as a statutory employee do not constitute the carrying on of a trade or business for purposes of SECA. Statutory employees are required to file a separate Schedule C (Form 1040) for expenses incurred as a statutory employee, separate from a Schedule C (Form 1040) that reports net earnings from self-employment.

(1) Workers in three occupations will not be treated as employees for FICA, FUTA, or FITW purposes provided they meet certain qualifications. These workers are referred to as "statutory non-employees."

1. IRC 3508(b)(1) provides that, for all IRC purposes, qualified real estate agents are statutory non-employees.

2. IRC 3508(b)(2) provides that, for all IRC purposes, direct sellers are statutory non-employees.

3. IRC 3506 provides that, for purposes of subtitle C of the IRC relating to employment tax, qualifying companion sitters are statutory non-employees.

(1) The FSL/ET Area under Exempt Organizations and Government Entities (EO/GE) is responsible for compliance activities affecting government entities. Examination of these entities will not be initiated by other operating divisions without the express written approval of the EO/GE Director.

(1) State and local government employees can be covered for social security and Medicare purposes through an agreement between the state and the Social Security Administration (SSA).

(2) Each state's original Section 218 Agreement incorporates the basic provisions, definitions, and conditions for coverage. Additional coverage is provided by modifications. Each modification, like the original Section 218 Agreement, is binding upon all parties. The initiative for securing coverage lies with the state.

(3) Coverage under a Section 218 Agreement must be provided for employees by groups. A Section 218 Agreement may be modified to increase the extent of coverage but generally not to reduce the amount of coverage. (An exception applies to election worker services and solely fee–based positions.)

(1) A public retirement system is a pension, annuity, retirement, or similar fund or system established and maintained by a state or political subdivision (or an agency or instrumentality thereof) that provides retirement benefits to its employees that are comparable to the benefits provided under the Old-Age portion of the Old-Age Survivors and Disability Insurance (Social Security) part of FICA. See Treas. Reg. 31.3121(b)(7)-2 for further information on the requirements for a public retirement system.

(2) Social security is NOT a public retirement system for purpose of the definition in (1).

(1) The FSL/ET Area under EO/GE has the primary responsibility for examination of state and local government entities.

(2) Any unusual issues or trends uncovered by other operating divisions will be referred to the Director of EO/GE.

(1) Federal agencies are generally bound by the same statutory and common law rules as the private sector. The FSL/ET Area under EO/GE has overall responsibility for employment compliance efforts involving federal agencies.

(2) There are unique protocol issues for federal agencies, including the military. If a compliance issue or lead involving a federal agency is received by another IRS office, this lead or issue will be referred to the FSL/ET Area under EO/GE using the Specialist Referral System.

(3) Guidance has been provided to federal employers by the Office of Personnel Management on the employer-employee relationship and the proper classification of workers.

(1) The successor may count the taxable wages paid by the predecessor to a continuing employee for purposes of the total FICA and FUTA wage limitations if:

1. An employer during any calendar year acquires all or substantially all of the property used in the trade or business of a predecessor employer or a unit of the business of such employer,

2. The employee was employed in the trade or business of the predecessor employer immediately prior to the acquisition and is employed by the successor employer in its trade or business immediately after the acquisition, and

3. Such wages were paid during the calendar year in which the acquisition occurred and prior to such acquisition.

(2) The acquisition may also occur as a result of the incorporation of a business by a sole proprietor or a partnership. In addition, a previously existing partnership that is continued by a new partnership or by a sole proprietorship may allow the successor to count the taxable wages paid by the predecessor employer of a continuing employee.

(3) For additional information, see Treas. Reg. 3121(a)(1)-1(b)(2) and Rev. Proc. 2004-53, which provide rules concerning predecessor/successor wage issues.

(1) Payroll Service Providers (PSP) and Reporting Agents prepare and file employment tax returns under each employer’s Employer Identification Number (EIN). For employers who use either a PSP or Reporting Agent, the examiner will instruct the employer to take the following actions to ensure timely filing of its tax returns, deposits, and/or payments:

• Verify its employer address is the address of record with the IRS, not the address of the PSP or Reporting Agents. This will ensure the employer remains informed of tax matters involving its business because the IRS will correspond to the employer’s address of record if there are any issues with an account. Examiners must check IDRS and inform the employer of the address on file. Further, the examiner will instruct the employer that it could verify the address of record by calling the phone number listed at "Business and Specialty Tax Line and EIN Assignment" listed on the "Telephone Assistance Contacts for Business Customers" page at https://www.irs.gov/businesses/telephone-assistance-contacts-for-business-customers.

• Verify the PSP or Reporting Agent uses the Electronic Federal Tax Payment System (EFTPS) when making employment tax deposits and payments,

• Enroll in EFTPS so the employer can view EFTPS deposits and payments made on its behalf under its Employer Identification Number. Information about enrolling on EFTPS can be found at https://www.eftps.gov/eftps/.

  Note: EFTPS will issue Inquiry PINs to all employers who are registered on EFTPS by their TPPs. Inquiry PINs allow employers to view their deposit history without a separate EFTPS enrollment.

(2) An examiner conducting an audit of an employer using a PSP or Reporting Agent must document in the case file that the examiner provided the above information to the taxpayer.

(3) Rev. Proc. 2012-32 requires a Reporting Agent to provide clients with a quarterly, written statement. The written statement must advise the client that it remains responsible for the timely filing of tax returns and timely payment of employment taxes, even if the client authorizes a Reporting Agent to file returns and make payments on its behalf. This statement also includes a recommendation for the client to enroll in EFTPS to monitor its account.

(1) An employer may request authorization from the IRS on Form 2678, Employer/Payer Appointment of Agent, to appoint an IRC 3504 agent to act on behalf of the employer with regard to its employment tax obligations. Once the IRS has approved Form 2678, the IRC 3504 agent assumes liability along with the employer for the employer’s Social Security tax, Medicare tax, and FITW, reporting, and payment responsibilities with regard to wages the agent pays. An IRC 3504 agent with an approved Form 2678 must file aggregate Forms 941 (e-file or paper) using the IRC 3504 agent’s EIN. The IRC 3504 agent generally cannot file aggregate Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, returns using the IRC 3504 agent’s EIN. An IRC 3504 agent with an approved Form 2678 must attach a Schedule R (Form 941), Allocation Schedule for Aggregate Form 941 Filers, to the aggregate Form 941 to provide an allocation of the aggregate amounts reported on the employment tax return filed by the IRC 3504 agent.

(2) Examiners may review Schedule R (Form 941) information that has been filed electronically in the EUP, Employee User Portal.

(3) Examiners will advise the employer that it remains liable along with the IRC 3504 agent. In addition, the examiner will advise the employer to use due diligence in requesting authorization from the IRS to appoint an IRC 3504 agent on Form 2678, and to continue to use the IRC 3504 agent after the authorization is approved.

(1) A Professional Employer Organization (PEO) might file an aggregate Form 941 using the PEO’s EIN. Examiners will advise an employer using a PEO that, generally, the employer is not relieved of its employment tax obligation with regard to wages paid to its employees by using a PEO. In addition, the examiner will advise the employer to use due diligence in selecting and continuing to use the services of any PEO. Examiners auditing an employer who is using a PEO/CPEO must also contact the analyst in Specialty Exam Policy and Quality, Employment Tax, for current procedures addressing PEO issues relating to certain third parties (including PEOs) that are subject to Treas. Reg. 31.3504-2, "Designation of Payor to Perform Acts of an Employer." Examiners must provide the following information:

• Name and EIN of client,

• Tax periods under examination, and

• Name and EIN of PEO.

(2) Additional information and links to guidance on employee leasing companies can be found at: Employee Leasing Preferred Employee Organization CHP (Cafeteria and Health Plans) (https://irsgov.sharepoint.com/sites/ETD-KMT-KB014/SitePages/Exam%20Case%20Issues/Cafeteria%20and%20Health%20Plans/Employee-Leasing-Preferred-Employee-Organization-CHP.aspx).

(1) The Stephen Beck, Jr., Achieving a Better Life Experience (ABLE Act) Act of 2014, was enacted on December 19, 2014, as part of The Tax Increase Prevention Act of 2014 (P.L. 113-295). Provision 206 of the ABLE Act established a voluntary for Professional Employer Organizations (PEOs) certification program. Two new IRC sections were enacted, IRC 3511 and IRC 7705, which provide requirements and definitions for certified PEOs.

(2) A certified professional employer organization (CPEO) is an entity certified by the IRS to perform federal employment tax withholding, reporting, and payment functions related to the wages it pays to workers performing services for its customers. Under a CPEO contract between a customer and a CPEO, the CPEO pays wages to the customer’s workers and is responsible for the withholding, reporting and paying of federal employment taxes with regard to these wages.

(3) Once certifications are effective, the IRS will publish on irs.gov a list of all organizations that are certified as CPEOs, and the effective date of their certification at the CPEO page on a quarterly basis, by the 15th day of the first month of every calendar quarter. The IRS will also publish lists of CPEOs whose certification has been revoked or suspended. See https://www.irs.gov/tax-professionals/cpeo-public-listings.

(4) CPEOs use Form 8973, Certified Professional Employer Organization/Customer Reporting Agreement, to notify the IRS that a CPEO contract between a CPEO and a customer has started or ended. A CPEO files aggregate returns using the CPEOs EIN. The CPEO is required to attach a Schedule R (Form 941) to its aggregate return. Examiners may review Schedule R (Form 941) information that has been filed electronically in the EUP.

(5) CPEOs are required to electronically file Form 941 and Form 940. Under certain circumstances, the IRS may waive the electronic filing requirement.

(1) After a fringe benefit is identified, it is necessary to determine whether there is a statutory provision that specifically excludes it from gross income. The IRC excludes the following fringe benefits from income:

(2) For a statutory exclusion to apply to an identified fringe benefit, the requirements of the IRC section must be met. Even if an exclusion applies, the result may be that the value of the fringe benefit is only partially excludable from the employee’s wages.

(1) IRC 132(a) provides that gross income shall not include any fringe benefit that qualifies as one of the following:

• No-additional-cost service,

• Qualified employee discount,

• Working condition fringe,

• De minimis fringe,

• Qualified transportation fringe,

• Qualified moving expense reimbursement,

• Qualified retirement planning services, or

• Qualified military base realignment and closure fringe.

(2) No–Additional–Cost Services: IRC 132(b) applies when an employee receives a free service at no substantial additional cost (including foregone revenue) to the employer. Generally, no–additional–cost services are only available to employees with respect to services that are offered for sale to customers in the ordinary course of the same line of business in which the employee performs substantial services for the employer. Generally, no–additional–cost services are excess capacity services, such as airline tickets or hotel rooms.

(3) Qualified Employee Discount: IRC 132(c) applies to a price reduction an employer gives an employee on qualified property or services that are offered to customers in the ordinary course of the same line of business in which the employee performs substantial services for the employer. The discount on services is limited to 20 percent of the price charged to customers. The discount on merchandise cannot exceed the gross profit percentage times the price charged to customers for the item.

(4) Working Condition Fringe: IRC 132(d) applies to any property or service provided to an employee to the extent that, if the employee paid for it, the amount paid would be allowable as a deduction as an ordinary and necessary business expense under IRC 162 or IRC 167. This exclusion applies to property and services provided by an employer to an employee, necessary for an employee to perform their job. Examples of working condition fringe benefits include an employee's use of a company car for business or the provision of job-related education.

(5) De minimis Fringe: IRC 132(e) applies to any property or service provided to employees that is provided infrequently and has so little value that accounting for it would be unreasonable or administratively impracticable. A cash fringe benefit (or cash equivalent) is never excludable as de minimis, regardless of amount, except for occasional meal money or transportation fare meeting certain conditions. Examples of de minimis fringe benefits include:

1. Occasional personal use of a company copying machine,

2. Occasional parties or picnics for employees and their guests,

3. Occasional tickets for entertainment or sporting events,

4. Flowers or fruit for special occasions, and

5. Holiday gifts, other than cash, with a low fair market value (FMV).

(6) Qualified Transportation Fringes: IRC 132(f) and applies to the following benefits:

1. A ride in a commuter highway vehicle, under IRC 132(f)(5)(A), meaning any highway vehicle that transports the employee between the employee's home and workplace. The vehicle must seat at least 6 adults (excluding the driver) and the expectation must exist that at least 80 percent of the vehicle's mileage will be for transporting employees between home and work. Employees must occupy at least one-half of the seats, not including the driver.

2. A transit pass, under IRC 132(f)(5)(B), meaning any mass transit pass, token, farecard, or voucher entitling a person to ride free or at a reduced rate on a mass transit system or in a commuter highway vehicle as defined previously.

3. Qualified parking, under IRC 132(f)(5)(C), meaning parking that the employer provides to employees on or near the employer's business premises. It also includes parking on or near the location from which employees commute to work using mass transit, commuter highway vehicles, carpools or any other means.

(7) Qualified Moving Expense Reimbursement: IRC 132(g) applies to any amount given to an employee, directly or indirectly, as payment for, or a reimbursement of, moving expenses. Only those expenses that the employee could deduct under IRC 217, if the employee had paid or incurred them, are excludable. Any other expenses paid by the employer on behalf of the employee are includible as compensation subject to employment taxes. Examples of non-excludable expenses include house-hunting trips, storage of goods, closing costs, and interest free or low interest loans when an employee's former home has not sold. Expenses that qualify under this exclusion are limited to reasonable expenses for:

1. Moving household goods and personal effects from the former home to the new home, and

2. Traveling expenses, including lodging, from the former home to the new home.

(8) Qualified Retirement Planning Services: IRC 132(m) applies to any retirement planning advice or information provided to an employee and the employee's spouse by an employer maintaining a qualified employer plan. A qualified plan includes an employer's pension, profit-sharing, or stock bonus plan. It also includes an annuity plan described in IRC 403(a) or IRC 403(b), a simplified employee pension within the meaning of IRC 408(k) and any simple retirement account described in IRC 408(p).

(9) Qualified Military Base Realignment and Closures: IRC 132(n) applies to certain payments to offset the adverse effects on housing values as a result of a military base realignment or closure.

(10) On-Premises Athletic Facilities: IRC 132(j)(4)(B) applies to an on–premises athletic facility operated by the employer in which substantially all of the use is by employees, their spouses, and their dependent children. The athletic facility must be located on premises that the employer owns or leases. A public facility or a facility for residential use does not qualify for this exclusion.

(1) A non–cash fringe benefit is typically valued at its fair market value. This is the amount an employee would have to pay a third party in an arm's–length transaction to buy or lease the benefit. Refer to Treas. Reg. 1.61-21(b).

(2) Treas. Reg. 1.61-21 provide special valuation rules for some commonly provided fringe benefits such as automobile and airplane travel.

(1) Fringe benefits can be a significant form of compensation, and examiners should consider fringe benefit issues during an examination. Fringe benefits can be identified from a number of sources. Examiners should inspect the following documents and records, if available:

(2) Examiners should also look at expense categories that are less obvious but may include fringe benefits such as miscellaneous expenses, meetings, automobile expense, insurance, tax preparation, and travel expense reimbursements.

(3) When discussing fringe benefits with the taxpayer, it is important that examiners communicate with the appropriate parties. For example, personnel in the payroll department may not have the same awareness of benefits as those in the human resources department. Discussions with other IRS personnel who may be involved in the examination are also important because they may encounter potential employment tax issues in the course of their assigned examinations to be addressed in the employment tax exam.

(1) Non-cash fringe benefits are includible in the employee's wages in either the pay period, the quarter or any other period the employer chooses, as long as the fringe benefits are treated as paid at least once per calendar year. Employers do not have to make the same election for all employees and may change their election as frequently as they desire. Employers may treat the value of non-cash fringe benefits provided during the last two months of the calendar year or any shorter period as paid during the subsequent calendar year. Refer to Announcement 85-113, which provides the rules for the timing of inclusion in wages.

(2) Fringe benefits are subject to all employment taxes including social security, Medicare, FUTA, and FITW unless special rules apply.

(1) A non-qualified deferred compensation (NQDC) plan is an elective or non-elective arrangement between an employer and an employee to pay the employee compensation some-time in the future. NQDC plans differ from qualified plans in that they do not meet all of the requirements of IRC 401(a). The terms of these arrangements differ widely, but their common objective is to provide tax deferral for a specified period. NQDC plans may provide for payment upon retirement, death, disability, or termination of employment. Others may permit payment after a specified number of years.

(2) In contrast to the general timing rule under which remuneration is subject to FICA tax when "actually or constructively paid" (Treas. Reg. 31.3121(a)-2(a)), amounts deferred under a NQDC plan are subject to FICA tax under a special timing rule. NQDC is taxed (taken into account) only once. When amounts are paid from the plan in a later period, they are not subject to additional FICA and FUTA taxes provided the amounts were properly taken into account at the time of deferral. In addition, any earnings attributed to the amounts deferred are likewise not subject to FICA or FUTA. This rule is commonly called the non-duplication rule. Amounts deferred under a NQDC plan are subject to FICA tax at the later of:

1. When the services are completed, or

2. When there is no substantial risk of forfeiture.

(3) Participants in NQDC plans may include:

• Key executives and/or directors

• A select group of management or highly compensated employees

• Employees whose benefits are limited by qualified plan rules

• Any other employee whom the employer wishes to reward

(4) The most commonly used types of NQDC plans are salary reduction arrangements, bonus deferral plans, top-hat plans, and excess benefit plans.

• Salary reduction arrangements: This type of plan simply defers the receipt of otherwise currently taxable compensation by allowing the executive to select a percentage or dollar amount to be taken out of current salary and have the employer pay the deferred amount at a future date.

• Bonus deferral plans: This is similar to a salary reduction arrangement, except that it defers receipt of an employee’s bonus.

• Top-hat plans: Also known as Supplemental Executive Retirement Plan (SERP). These are NQDC plans primarily for a select group of management or highly compensated employees to supplement qualified retirement plans.

• Excess benefit plans: Also known as benefit equalization plans or benefit replacement plans. These are NQDC plans that provide benefits to employees whose benefits under the employer’s qualified plan are limited by IRC 415.

(5) All NQDC plans are either unfunded or funded. Most NQDC plans are intended to be unfunded arrangements because of the tax advantages. With an unfunded arrangement, the employee has only the employer’s "mere promise to pay" the deferred compensation in the future and the promise is not secured in any way. The employer may simply keep track of the benefit in a bookkeeping account or may invest the funds in annuities, securities, or insurance arrangements. In order to help fulfill its mere promise to pay the employee, the employer may transfer funds to a trust that remains a part of the employer’s general assets, subject to the claims of the employer’s creditors upon insolvency.

(6) Generally, a funded arrangement exists if assets are set aside from the claims of the employer’s creditors, for example, in a trust, escrow, or annuity.

(7) For more information on NQDC refer to Pub 5528, Nonqualifed Deferred Compensation Audit Technique Guide.

(1) Stock in the employer's company is a commonly used form of compensation for employees and may also be provided as compensation for service providers who are not employees, such as outside directors. Stock–based compensation includes any compensation paid to an employee or independent contractor, either in cash or property, that is based on the value of the stock. This includes stock options, restricted stock awards, stock appreciation rights and phantom stock.

(2) A stock option is the right to purchase a given number of shares of stock at a given price within a specified period of time. Stock options granted in connection with the performance of services are either statutory or non-statutory stock options. Statutory options include incentive stock options under IRC 422 and options issued under an employee stock purchase plan under IRC 423. All other options are non-statutory options governed by IRC 83 and Treas. Reg. 1.83-7.

(3) Non-statutory Stock Options: Any option that does not qualify for treatment as a statutory option is a non-statutory option. Most non-statutory stock options are taxed on the date of exercise or other disposition. The amount includible in income is the difference between the fair market value of the stock on the exercise date over the amount paid (spread amount). If an option is sold or otherwise disposed of prior to exercise, the money or property received is includible in income. The income is characterized as compensation income to the recipient for the year in which the option is exercised or the option is sold or otherwise disposed of prior to exercise.

1. In the case of an employee, the amount includible in income under IRC 83 with respect to non-statutory stock options is also subject to FICA, FUTA, and FITW and must be reported on Form W-2. Non-employees, such as directors or outside contractors, are issued a Form 1099-MISC or Form 1099-NEC.

2. A corresponding compensation expense deduction is generally allowed to the employer for the taxable year in which the optionee's taxable year of inclusion ends. See IRC 83(h) and Income Treas. Reg. 1.83–6(a)(1) and the exception provided to this general rule in Treas. Reg. 1.83–6(a)(3). This expense generally is identified on the corporate income tax return as a Schedule M-1 (Form 1120) adjustment under "Deductions on this return not charged against book income" or on Schedule M-3 (Form 1120), Part III, Line 9, as a stock option expense.

(4) Statutory Stock Options: While non-statutory stock options may be provided to any service provider, statutory options may be granted only to employees. IRC 421 to IRC 424 contain a set of requirements, all of which must be followed, for an option to be considered statutory. Violating any of these rules results in the option being disqualified. The result of disqualification is that the option is considered to be a non-statutory option that is taxable under the rules of IRC 83. Statutory options include incentive stock options and options granted under an employee stock purchase plan.

(5) Incentive Stock Options: Incentive stock options (ISOs) are governed by IRC 422 and are not subject to the anti-discrimination rules. Although there are no anti-discrimination rules, there are still some rules addressing ISOs given to stockholders with a certain ownership percentage. The options can never be granted with an exercise price that is less than the FMV of the underlying stock on the date of grant. Gain from the sale of the stock purchased under the ISO is includible in gross income of the employee only upon sale or other disposition of the stock.

(6) Employee Stock Purchase Plans: Employee stock purchase plans (ESPPs) are governed by IRC 423 and are intended for all employees, with certain exceptions. See IRC 423(b)(4) for employees that may be excluded. All employees must be given an opportunity to participate in the plan without discrimination, with exceptions for new, part-time, seasonal, or highly compensated employees. The option to purchase stock can be price discounted but cannot be less than the lesser of 85 percent of the FMV of the stock on the date of grant or 85 percent of the value of stock on the date of exercise.

(7) Disqualifying dispositions, under IRC 421(b), occur when stock acquired under a statutory stock option plan is sold or otherwise disposed of prior to the expiration of the applicable holding period. This is generally the later of two years after the date the option is granted or one year after the date the option is exercised. The income realized on the disqualifying disposition is treated as compensation to the extent of the spread amount (or gain if less for ISOs). This compensation is included in the employee's Form W-2, but is not subject to FICA, FUTA, or FITW.

(8) The exercise and qualifying disposition of stock acquired pursuant to a statutory stock option plan provide no tax deduction for the employer. See IRC 421(a)(2). However, the employer is entitled to a deduction for the amount the employee recognizes as compensation on a disqualifying disposition. See IRC 421(b).

(9) IRC 3121(a), IRC 3306(b), IRC 421(b) and IRC 423(c) were amended by the American Jobs Creation Act (AJCA) of 2004 to address the application of FICA and FUTA taxes and FITW to statutory stock options. See IRC 3121(a)(22) and IRC 3306(b)(19). These sections provide that any exercise of a statutory stock option or disposition of stock acquired pursuant to such exercise will not result in wages for purposes of FICA and FUTA. Furthermore, income tax withholding will not apply to a disqualifying disposition or with respect to the ordinary income recognized upon a qualifying disposition of stock acquired pursuant to an employee stock purchase plan. These amendments are effective for exercises of statutory stock options exercised after October 22, 2004.

(10) Prior to the AJCA amendments, the position of the IRS was set forth in Notice 2001-14 and Notice 2002-47. Notice 2001-14 placed a retroactive moratorium on any assessments until January 1, 2003. The notice provides that the IRS will not enforce application of FICA and FUTA taxes upon the exercise of statutory stock options and will not enforce the application of FITW upon the sale or disposition of stock acquired pursuant to such options. Notice 2002-47 effectively extended the moratorium.

(11) TCJA section 13603 "Treatment of qualified equity grants" added IRC 83(i) . Under IRC 83(i), qualified employees who are granted stock options or restricted stock units (RSUs) and who later receive stock upon exercise of the option or upon settlement of the RSU (qualified stock) may elect to defer the recognition of income for up to 5 years if the corporation's stock was not readily tradable on an established securities market during any prior calendar year, if the corporation has a written plan under which not less than 80 percent of all U.S. employees are granted options or RSUs with the same rights and privileges to receive qualified stock, and if certain other requirements are met. An election under IRC 83(i) applies only for federal income tax purposes. The election has no effect on the application of FICA and FUTA. These rules apply to stock attributable to options exercised, or RSUs settled, after December 31, 2017.

(12) Stock option plans are identified in a corporation's annual reports and also in reports filed with the SEC, such as Form 10-K and proxy statements. Examiners will inspect the Schedule M-1 or M-3 adjustments on the employer's income tax returns. Any income tax expense deductions taken in regard to stock-based compensation may appear as a deduction on the return that was not taken for book purposes.

(1) A corporation may have contracts with key personnel that provide for payments to be made if an executive loses their job as a result of a change in ownership or control of the company. These payments are referred to as "golden parachute payments."

(2) IRC 280G applies to the payor and disallows the deduction of an "excess parachute payment." IRC 4999 applies to the recipient and imposes a 20 percent nondeductible excise tax on any such payment. The excise tax must be withheld by the payor (refer to IRC 4999(c)(1) ). This excise tax is administered as an income tax under IRC 4999(c)(2). In addition, wages constituting parachute payments are subject to FICA, FUTA, and FITW, the same as other termination payments.

(3) A payment is generally considered an excess parachute payment if its present value, along with the present values of all such payments, equals or exceeds three times the average annual compensation of the recipient over the previous five-year period. The amount of the payment in excess of the average annual compensation is the excess parachute payment.

(4) Payments under IRC 280G(b)(6), (payments pursuant to a qualified retirement plan), or IRC 280G(b)(4), (payments that the taxpayer establishes are reasonable compensation for services rendered on or after the date of change in control), are not considered parachute payments. In addition, parachute payments do not include payments made by a small business corporation or a corporation with no readily tradable stock if certain shareholder approval requirements are satisfied. See IRC 280G(b)(5).

(5) Golden parachute payments made to employees are reported on Form W–2 along with any taxes withheld. The total payment is included in Boxes 1, 3, and 5 and is subject to the usual income tax withholding, social security and Medicare taxes. The 20 percent excise tax on excess parachute payments is included in Box 2 as income tax withheld and is also reported in Box 12 with Code "K". The employee must include the 20 percent excise tax as other taxes on Form 1040 Schedule 2, Additional Taxes.

(6) Total golden parachute payments made to nonemployees are reported on Form 1099–NEC in Box 1, "Nonemployee Compensation." Any excess parachute payments are reported in Box 14, "Excess Golden Parachute Payments" of Form 1099-MISC. The payor of a parachute payment to an independent contractor would not have a withholding requirement. The recipient of the payment would determine the 20 percent excise tax on the amount shown in Box 14 and report it as other taxes on Form 1040 Schedule 2, Additional Taxes.

(7) To identify parachute payments, determine if a change in ownership or control has occurred. Changes in ownership or control may be determined by analyzing merger agreements, employment contracts, stock option plans, and deferred compensation plans. If a payment under certain benefit plans is accelerated, it may possibly be considered to be contingent on a change in ownership.

(8) Audit adjustments are made using the standard employment tax examination report forms. For employee adjustments, the 20 percent excise tax is computed on Form 4668 - Schedule of Adjustments, line 17, "Other income tax withholding wage adjustment" of Form 4668, Employment Tax Examination Changes Report.

(1) For periods after December 31, 2006, the examiner will determine whether the plan is abusive based on the extent of the excess payments that are not treated as wages and on whether a system for tracing excess payments is being utilized.

(2) There are four conditions to be addressed:

1. When does an employer routinely make payments in excess of the deemed substantiated amount? ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡

   Exception: ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡

   Note: If the condition is not met, excess payments will not constitute a pattern of abuse, absent other significant plan defects.

2. When does an employer fail to track excess allowances? If the condition above is satisfied, the agent must determine whether the employer has implemented and utilizes a system to track allowances that permits it to determine when the allowances paid, computed on a per diem basis, exceed the deemed substantiated amount and to treat such amounts as wages. If the agent determines the employer utilizes such a system, then the fact that the employer, due to errors in its system, routinely pays excess allowances that it does not treat as wages generally does not, on its own, evidence a pattern of abuse. Each case stands on its own, and a determination must be made based on the "facts and circumstances" of that particular case.

3. What happens if a plan evidences a pattern of abuse? If a plan evidences a pattern of abuse, all of the per diem payments made under the plan will be treated as taxable wages.

4. What happens if a plan does not evidence a pattern of abuse? If a plan does not evidence a pattern of abuse, but an employer has paid excess allowances without treating such amounts as wages, only the excess per diem payments will be considered taxable wages in the audit.

(1) If an expense reimbursement plan serves to recharacterize amounts previously paid as wages, amounts paid under it will not be treated as paid under an accountable plan. Such recharacterization violates the business connection requirement of Treas. Reg. 1.62-2(d) because the employees receive the same amount regardless of whether expenses are incurred, the only difference being the ratio of the amount treated as taxable wages to the amount treated as nontaxable reimbursement. Consequently, all reimbursement allowances paid under the plan must be treated as paid under a nonaccountable plan, must be included in the employee's gross income, and must be reported as wages for FICA tax, FUTA tax, and FITW purposes. The recharacterization as a reimbursement allowance of amounts previously paid as wages violates the business connection requirement of Treas. Reg. 1.62-2(c) regardless of whether the employee actually incurs (or is reasonably expected to incur) deductible business expenses related to the employer's business. See Rev. Rul. 2012-25.

(2) Examiners should be alert to the split of wages between taxable wages and per diem payments, most often paid to employees who provide services through a temporary staffing service or other temporary employment arrangement and have to travel for the job. The payment arrangement typically pays the employee an hourly rate, but the rate is divided between taxable wages and "per diem" payments. The combined rate is comparable to the taxable wage rate paid to employees who work in the same location but do not travel for the job.

(3) Examiners who encounter this issue are to contact the Employment Tax Policy Analyst responsible for accountable plans for more guidance on this issue.

(1) Some whistleblower information, such as information that may be subject to a valid claim of privilege, may create risks if used by the IRS; this information is "tainted". If potentially tainted information is identified at any time during the review of the whistleblower’s information (for example Employment Tax - Workload Selection and Delivery (ET-WSD) or in the field), the reviewer/examiner will contact the Lead SME and request a taint review. The Lead SME will assign a SME to conduct the taint review of the potentially tainted information and the SME will coordinate with the Operating Division Counsel to determine whether information is subject to a recognized privilege. The IRS will not use information subject to attorney client privilege or the federally authorized tax practitioner privilege. If it is determined that the information will not be used, it will immediately be returned to the Whistleblower Office’s ICE Team in Ogden in a double-sealed envelope along with any analysis received from Counsel regarding the use of the information. The SME will provide a memorandum for the case as to the final result of the taint review to be posted on e-trak and included in the case file.

(2) Taint Review: In general, the goal of the taint review is to determine whether any information provided by the whistleblower may be barred from introduction into evidence in later court cases. The most common cause of evidence preclusion is that the evidence is subject to a legal privilege, such as attorney-client privilege or the federally authorized tax practitioner privilege. Other instances of tainted information (whether potentially inadmissible or not) might include evidence obtained illegally (for example document stolen from the taxpayer by the whistleblower), documents obtained in violation of employment agreements between the whistleblower and the taxpayer, or documents containing trade secrets (for example if the whistleblower is a current employee and the whistleblower obtained the documents without authorization).

(3) The examiner/team will not contact the whistleblower for additional information. If the examiner/team determines that debriefing the whistleblower would result in information that would be material to the evaluation of the submission, the examiner/team should contact the Lead SME. The Lead SME will assign the debriefing to a SME. A debriefing may yield additional information that the whistleblower did not recognize as relevant to the taxpayer’s matters, information about the credibility of the whistleblower, information relevant to legal issues that can affect the use of documents, and leads to other sources of information. A debriefing may also clarify the whistleblower’s submission.

(1) If it is determined that a whistleblower’s claim with regard to employment taxes is equal to or less than the $2 million threshold (tax, penalties, interest, additions to tax, and additional amounts in dispute), the WO will designate it as an "a" claim (Tracking Code 7882 "Referrals – Form 211 7623(a)"). All "a" claims are sent from the WO to the Employment Tax - Workload Selection and Delivery unit (ET-WSD) for review and classification. Generally, the WO will not perform any screening or case building on "a" claims.

(2) Referrals selected upon classification by ET-WSD are sent to the field with the controls established, the appropriate project code based on the key issue identified during classification, the appropriate Whistleblower tracking code, and the appropriate freeze code. Included in the selected case will be an "instructional insert" along with specific instructions from the WO on required closing procedures.

(3) If the referral is related to an open employment tax examination, the information will be forwarded to the group for association. The appropriate freeze code will be added to the established controls.

(4) See IRM 25.2.1.5, Working a Whistleblower Claim, for detailed procedures.

(1) If a whistleblower’s claim with regard to employment taxes is greater than the $2 million threshold (tax, penalties, interest, additions to tax, and additional amounts in dispute), the WO will designate it as a "b" claim.

(2) On all "b" claims, the WO will conduct preliminary screening and case building. If the initial claim is accepted, the claim will be forwarded to ET-WSD.

(3) A whistleblower must meet several conditions to qualify for an award under IRC 7623(b). The whistleblower’s information must be:

1. Signed and submitted under penalty of perjury,

2. Relate to an action in which the tax, penalties, interest, additions to tax, and additional amounts in dispute exceed $2,000,000, and

3. Relate to a taxpayer, and for individual taxpayers only, whose gross income exceeds $200,000 for at least one of the tax years in question.

(4) If the information meets the conditions in (3) above and substantially contributes to an administrative or judicial action that results in the collection of tax, penalties, interest, additions to tax, or additional amounts, the IRS will pay an award under IRC 7623(b). If the whistleblower does not meet these requirements, then IRC 7623(a) may apply, and the referral will be processed as outlined in IRM 4.23.5.20.2, IRC 7623(a) Whistleblower Claims.

(5) For additional information, see IRM 25.2.1, General Operating Division Guidance for Working Whistleblower Claims.

(1) A QSB is a corporation (including an S corporation), partnership, or any other taxpayer (excluding not-for-profit organizations), with gross receipts of less than $5 million for the current tax year, and no gross receipts for any tax year before the 5 taxable year period ending with the current tax year.

(2) Gross receipts are determined under IRC 448(c)(3) without regard to IRC 448(c)(3)(A). Gross receipts must be annualized for short tax years, reduced by returns and allowances, and adjusted for predecessor entities.

(3) A single taxpayer under IRC 41(f)(1) includes a controlled group or corporation, or businesses or trades under common control. Entities or persons treated as a single taxpayer under IRC 41(f)(1) are treated as a single taxpayer under IRC 41(h).

1. Each of the persons treated as a single taxpayer may separately make the QSB election under IRC 41(h)(1) for any taxable year, and

2. The election amount shall be allocated among all persons or members treated as a single taxpayer, as provided in IRC 41(f)(1), meaning on a proportionate basis based on its share of the aggregate of the qualified research expenses, basic research payments, and amounts paid or incurred to energy research consortiums, taken into account by such controlled group or all such persons under common control.

(4) For purposes of the gross receipts test, a single taxpayer must determine gross receipts as follows:

1. Gross receipts must be aggregated for all entities or persons treated as a single taxpayer.

2. Gross receipts includes but are not limited to investment income such as annuities, dividends, interest, rents, and royalties, but does not include items such as loan repayments or sales tax. See Treas. Reg. 1.448-1T(f)(2)(iii) and (iv).

3. The gross receipts exception under IRC 41(c)(7) and Treas. Reg. 1.41-3(c) does not apply to qualification as a QSB.

(1) Form 3800, General Business Credit, is used by taxpayers to claim any of the general business credits. Form 6765, Credit for Increasing Research Activities, may be used by individuals, estates, trusts, organizations, or corporations to figure and claim the payroll tax credit for increasing research activities. Forms 3800 and 6765 must be attached to the taxpayer’s income tax on which the credit is elected.

(2) A QSB must complete Form 3800 before completing Section D of Form 6765 if the payroll tax credit is being claimed.

(3) A partnership or S corporation must file Form 6765 to claim the payroll tax credit. Any other taxpayer must file Form 6765 unless their only source for this credit is a partnership, S corporation, estate, or trust, in which case the taxpayer can report the payroll tax credit directly on Form 3800.

(4) The payroll tax research credit that may be elected is the smallest of:

1. The current year research credit,

2. An elected amount not to exceed $250,000 (for tax years beginning on or prior to December 31, 2022,) or $500,000 (for tax years beginning after December 31, 2022), or

3. The general business credit carryforward for the tax year, before the application of the payroll tax credit election for the tax year.

(5) The election amount for entities or persons treated as a single taxpayer is limited to the smallest of their allocable share of the items of paragraph (4)(a) to (c) of this subsection.

(6) For partnerships or S corporations, the payroll tax research credit election is made at the entity level, and the general business credit carryforward limitation does not apply.

(7) The payroll tax research credit election:

1. Is an annual election that must be made on or before the due date of the originally filed income tax return (including extensions).

2. Can be made for a tax year if the election was not made for five or more preceding tax years.

3. May be revoked only with the consent of the IRS.

Note: If the Research Credit claim on the income tax return appears unusual or potentially suspicious, discuss the claim with an IRC 41 subject matter expert (SME). You may contact the SME at "sbse.abusive.transactions.re.credit@irs.gov."

(1) The payroll tax research credit claimed by an employer on an income tax return and then applied on an employment tax return cannot exceed the employer’s share of applicable FICA tax for any calendar quarter on wages paid with respect to the employment of all individuals in the employ of the employer. These limits are:

1. For tax years beginning in 2022 and prior, the maximum credit that can be elected on Form 6765 is $250,000. For tax years beginning after December 31, 2022, the maximum credit that can be elected on Form 6765 is $500,000.

2. For payroll tax returns filed for 2022 and prior, the credit can only be applied against the employer’s share of social security tax.

3. For payroll tax returns filed for or after the first quarter of 2023, the credit can be applied first to the employer’s share of social security tax up to a limit of $250,000, and then to the employer’s share of Medicare tax.

(2) A QSB uses Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, to apply these limits to the amount of the payroll tax credit it elected on Form 6765, and to allocate the research credit from Form 6765 to the specific employer that will claim the credit on their employment tax return to the extent of the available employer’s share of employment taxes.

(3) The amount of payroll tax research credit claimed on Form 6765 in excess of the employer’s share of applicable FICA tax for the calendar quarter, as determined on Form 8974, is carried over to the succeeding calendar quarter(s) and allowed as a payroll tax credit for the succeeding quarter(s), subject to the social security tax limitation applicable to the quarter(s).

(4) A QSB that files quarterly payroll tax returns may apply the credit on its payroll tax return for the first quarter beginning after it files the federal return appropriately reflecting the election. A QSB that files annual payroll tax returns may apply the credit on its payroll tax return that includes the first quarter beginning after the date on which the business files the federal return appropriately reflecting the election.

(1) With respect to the timing of the payroll tax credit for purposes of calculating deposit liabilities, the employer will apply the credit against deposit liabilities as the employer incurs liability for the employer’s share of applicable FICA tax on wages paid in the quarter to which it applies, beginning with the first payment of wages in the quarter. Therefore, the payroll tax research credit is not a refund of tax paid, but rather is a genuine credit.

1. For tax years beginning after December 31, 2022, the credit would be applied against the employer’s share of social security tax (up to $250,000) and then to the employer’s share of Medicare for employment tax returns, up to the total employer’s share of Medicare shown on the return.

2. For tax years beginning on or before December 31, 2022, the credit would be applied against the employer’s share of social security tax.

3. An employer cannot take the payroll tax credit against employee social security tax or income tax withholding.

4. There should be no negative entries on the Schedule B (Form 941).

(2) The payroll tax credit is applied to succeeding liabilities on the Schedule B within the quarter until it is used. Any excess credit not used in the quarter can be carried forward as a payroll tax credit to the following quarter, .

(3) Refer to legal advice issued by IRS Associate Chief Counsel number AM 2017-003, Timing Issues Related to Payroll Tax Credit for Increasing Research Activities (PRENO-120484-17), July 31, 2017 (https://www.irs.gov/pub/lanoa/am-2017-003.pdf.

(1) A third-party payer may apply the credit to an aggregate return filed on behalf of clients that qualify for and claim the IRC 41(h) QSB payroll tax credit for increasing research activities.

(2) An approved IRC 3504 agent or a certified professional employer organization (CPEO) must complete Schedule R (Form 941), Allocation Schedule for Aggregate Form 941 Filers, or Schedule R (Form 943), Allocation Schedule for Aggregate Form 943 Filers, when filing an aggregate Form 941 or Form 943, respectively. Other third-party payers such as non-certified PEOs must complete and file Schedule R (Form 941) only in certain circumstances, including when they have clients that are claiming the research payroll tax credit.

(3) For a third-party payer to claim the credit, the client must be a QSB (or an entity included in a QSB). The QSB must elect to apply the research credit against payroll tax liability by attaching Form 6765 to its timely filed income tax return. The amount of the payroll tax credit is determined on Form 6765 and then reported on each entities’ Form 8974.

(4) The third party payer must attach to its aggregate payroll tax return a Form 8974 for each client that is taking the payroll tax credit. See the IRS webpage, Qualified Small Business Payroll Tax Credit for Increasing Research Activities.

(5) If a QSB includes more than one entity and a third-party payer paid wages on behalf of only some of the entities claiming the research payroll tax credit on Form 6765, both the QSB entity and the third-party payer would attach Form 8974 to their payroll tax return, and each entity would claim only its respective share of the credit.

(1) An examination of the payroll tax research credit consists of an income tax examination to determine whether the credit is properly computed and claimed on a QSB’s income tax return, and a simultaneous employment tax examination or compliance check to determine whether the credit is properly allocated and applied to the employment tax return of the QSB or an entity included in a QSB.

(2) Income Tax Exam is responsible for determining whether the research credit is properly claimed and computed on Forms 3800 and 6765 of the QSB’s income tax return. Workload for Income Tax Exam is classified and selected by SB/SE Planning and Special Programs (PSP). For the payroll tax research credit, workload sources include returns identified and selected by PSP, and employment tax returns referred by Employment Tax Exam which are then filtered and accepted or rejected by PSP.

(3) The employment tax determination of whether the credit is properly allocated and applied on the related payroll tax return may be made by Income Tax Exam or Employment Tax Exam. The Exam group that makes the employment tax determination must:

1. Establish examination controls for the employment tax return (Form 941/MFT 01 or Form 943/MFT 11) for the period(s) in which the credit is applied to the employment tax return. For information on establishing examination controls on the Audit Information Management System (AIMS) and Examination Returns Control System (ERCS) refer to IRM 4.23.3.6.3.3, Controlling Employment Tax Returns,

2. Protect the employment tax return’s assessment statute. For more information refer to IRM 4.23.5.23.8, Statute of Limitations, and

3. Perform mandatory employment tax case procedures and prepare mandatory employment tax workpapers to support the employment tax determination. For more information refer to IRM 4.23.5.23.6.1.

(1) This subsection provides general guidelines and factors to consider when preparing a referral to SB/SE PSP.

(1) IRC 41(h) payroll tax election presents unique circumstances because it involves both an election made with an income tax return and a credit taken on an employment tax return. The recapture of the payroll tax credit involves an assessment against employment tax and therefore requires that the period of limitations on assessment of employment tax be open.

(2) The period of limitations relevant to the recapture of an invalid payroll tax research credit begins to run from the filing of the employment tax return (for example, Form 941, Form 943, or Form 944) on which the credit is taken, and not from the filing of the income tax return on which the payroll tax credit election is made.

(3) The amount of the payroll tax election taken on Form 6765, filed with the income tax return before the employment tax return is filed, is not necessarily the same as the amount of the payroll tax credit allocated to the employer on Form 8974 filed with the employment tax return. The elected amount is often divided among multiple employers or an aggregate return and/or carried forward to future employment tax return periods. It is not possible for the IRS to discern how much of the payroll tax credit may have been improper until the employment tax return is filed.

(4) Under IRC 6501(c)(4), a taxpayer can execute a consent to extend the period of limitations on assessment that is limited in scope to the payroll research tax credit. However, Form SS-10, Consent to Extend the Time to Assess Employment Taxes, is not readily modifiable, and the examiner will contact their local counsel for assistance in the preparation of the consent.

(5) Consent to extend the period of limitations on assessment will be sought in any case where a proposed adjustment may result in an increase of previously assessed tax. If the taxpayer claims the payroll research on an amended return (a claim), the consent will be sought if there are other employment tax issues under examination that may result in an increase in tax.

(1) For the period beginning April 1, 2020, through December 31, 2020, the FFCRA requires employers to provide paid leave through two separate provisions:

• The Emergency Paid Sick Leave Act (EPSLA), which entitles workers up to two weeks (but no more than 80 hours) of paid sick time when they are unable to work for certain reasons related to COVID-19, and

• The Emergency Family and Medical Leave Expansion Act (Expanded FMLA), which entitles workers to certain paid family and medical leave.

(2) The FFCRA provides that Eligible Employers subject to the EPSLA and the Expanded FMLA paid leave requirements are entitled to fully refundable tax credits to cover the cost of the leave required to be paid for these periods of time during which employees are unable to work (which for purposes of these rules, includes telework). For more information refer to sections 7001 and 7003 of the FFCRA.

(3) The Tax Relief Act extended the leave period for which qualified sick and family leave wages can be paid under the FFCRA, with certain modifications, through March 31, 2021. Though the mandate to provide sick and family leave under the EPSLA and Expanded FMLA expired on December 31, 2020, employers may still receive the credits for leave provided for periods beginning January 1, 2021, through March 31, 2021, for paid sick or family leave that would have satisfied the requirements of the EPSLA or Expanded FMLA.

(4) The ARP Act created a new leave period for which qualified sick and family leave wages can be paid beginning April 1, 2021, through September 30, 2021. The credits under the ARP Act were codified as IRC 3131, 3132, and 3133.

(5) For additional guidance on the Paid Sick and Family Leave Credits, refer to IRM 21.7.2.7.1, Credit for Qualified Sick and Family Leave Wages, and Training Publication 79909-002, COVID Credits and Deferrals Training for Employment Tax (Student Guide).

(1) Under section 2301 of the CARES Act, certain employers who pay qualified wages to their employees are eligible for an Employee Retention Credit.

(2) This Employee Retention Credit initially applied to qualified wages paid after March 12, 2020, and before January 1, 2021.

(3) Subsequent legislation extended to include qualified wages paid January 1, 2021, through December 31, 2021.

(4) For 2020, the Employee Retention Credit is a fully refundable tax credit for employers equal to 50 percent of qualified wages (including allocable qualified health plan expenses) that Eligible Employers pay their employees. The maximum amount of qualified wages taken into account with respect to each employee for all calendar quarters through December 31, 2020, is $10,000. Therefore, the maximum credit for an Eligible Employer for qualified wages paid to any employee is $5,000.

(5) For 2021, the legislation increased the credit to 70 percent of qualified wages (including allocable qualified health plan expenses) for $10,000 per employee per calendar quarter in 2021, so the maximum credit for an Eligible Employer for qualified wages paid to any employee is $7,000 per calendar quarter in 2021, for a total of $28,000 for 2021.

(6) For additional guidance on the Employee Retention Credit, refer to IRM 21.7.2.7.2, Employee Retention Credit (ERC), and Training Publication 79909-002, COVID Credits and Deferrals Training for Employment Tax (Student Guide).

(1) Employer-sponsored health plans generally are required to offer an employee, spouse, or dependent child covered by the plan the opportunity to continue coverage under the plan for a specified period of time after the occurrence of certain events that otherwise would have terminated the coverage (qualifying events). These continuation of coverage requirements, and corresponding coverage (if elected), are often referred to as "COBRA continuation coverage" or "COBRA requirements."

(2) Section 9501 of the ARP Act provides for a temporary 100 percent reduction in the premium otherwise payable by certain individuals and their families who elect COBRA continuation coverage due to a loss of coverage as the result of a reduction in hours or an involuntary termination of employment.

(3) Under section 9501(a)(3) of the ARP, an "Assistance Eligible Individual" is an individual (1) who is a qualified beneficiary with respect to a period of COBRA continuation coverage during the period from April 1, 2021, through September 30, 2021, and eligible for that COBRA continuation coverage by reason of a qualifying event specified in section 603(2) of ERISA, IRC 4980B(f)(3)(B), or section 2203(2) of PHS Act, except for voluntary termination of employment, and (2) who elects COBRA continuation coverage.

(4) The ARP Act added IRC 6432, which provides that the "person to whom premiums are payable for continuation coverage" is allowed a “premium assistance credit” for an amount equal to the premiums not paid by Assistance Eligible Individuals for COBRA continuation coverage.

(1) Generally, returns assigned for audits of the credits must be examined, whether they were received from Employment Tax – Workload Selection and Delivery (ET-WSD) through the normal classification process or from a referral from general program income tax exam. Approval from the examiner’s manager is required to survey these cases.

(2) Employment tax returns specifically classified for examination of the credits will not be designated as limited scope audits. Examiners will follow normal audit procedures and address any other issues worthy of examination.

(3) For employment tax returns classified for other issues through the normal classification procedures, examiners will determine whether any credits claimed by the employer will be examined based on the audit potential.

(4) When an entity is identified as an Indian Tribal Government or tribal government entity, refer to the service level agreement between SB/SE Exam and TE/GE, Post-filing Compliance Process for COVID-19 Employer Credits (https://irsgov.sharepoint.com/sites/ETD-KMT-KB062/RelatedResources/SBSE%20EXAM%20and%20TEGE%20AGREEMENT%20-%20COVID%20Employee%20Credits%20-%2005012022%20(2).pdf), to find procedures that must be followed prior to contact with the taxpayer.

(1) Project Code 0545 has been assigned to returns selected for audits of the credits.

(2) The following tracking codes will be assigned to the returns based on the specific reason for which the return was selected for audit:

• Tracking Code 2545 – Sick and Family Leave Pay

• Tracking Code 2546 – Retention Credits

• Tracking Code 3067 – SBA Loans

(3) If the audit is expanded to other periods, examiners will use the project and tracking code from the originally assigned return (key case).

(4) If the audit was not classified specifically for the credits but the examiner selects the credits as an audit issue, the examiner must use the original project and tracking codes from the originally assigned return (key case).

(1) Both the Paid Sick and Family Leave Credits and the Employee Retention Credit have an effect on the taxpayer’s income tax return.

(2) For the Paid Sick and Family Leave Credits:

1. For periods of leave beginning on April 1, 2020, through March 31, 2021, an Eligible Employer must include the full amount of the credits for qualified leave wages (and any allocable qualified health plan expenses and the Eligible Employer’s share of the Medicare tax on the qualified leave wages) in gross income.

2. For periods of leave beginning April 1, 2021, through September 30, 2021, an Eligible Employer must include the full amount of the credits received for qualified leave wages (plus allocable qualified health plan expenses, certain collectively bargained contributions, and the employer’s share of social security and Medicare taxes imposed on the qualified leave wages) in gross income.

(3) For the Employee Retention Credit:

1. Section 2301(e) of the CARES Act provides that rules similar to IRC 280C(a)shall apply for purposes of applying the Employee Retention Credit.

2. IRC 280C(a) generally disallows a deduction for the portion of wages paid equal to the sum of certain credits determined for the taxable year.

3. Accordingly, a similar deduction disallowance would apply under the Employee Retention Credit, such that an employer’s aggregate deductions would be reduced by the amount of the credit as result of this disallowance rule.

(4) Examiners must verify that an employer who received either the Paid Sick and Family Leave Credits or Employee Retention Credit (or both credits) made the appropriate adjustment on its income tax return.

(5) If the employer made the appropriate adjustment on its income tax return and the credit amount is being adjusted, the employer may be entitled to an income tax refund based on the reduced amount of the credit.

(6) If there is a corresponding income tax audit being conducted, the examiner will notify the income tax examiner of any adjustment to the credit so the income tax examiner can make the appropriate adjustment to income as part of the audit report.

(7) If there is no corresponding income tax audit being conducted, the examiner will notify the employer to do one of the following:

1. File an amended income tax return to correct the amount of the credit adjustment on its income tax return if the examination of the credit is completed and agreed before the period of limitations for filing an amended income tax return has expired, or

2. File a protective claim for the potential income tax refund once the audit of the credit is completed and resolved if the employment tax audit of the credit will not be completed (by the examiner or Appeals in an unagreed case) before the period of limitations for filing an amended income tax return will expire.

(8) If the employer did not make the appropriate adjustment on its income tax return, examiners will need to discuss the case with their group manager about referring the case to General Program Exam to have an income tax examiner open an income tax audit to make the appropriate adjustment.

(9) If the employer has not yet filed an income tax return, the examiner will provide the taxpayer with the proper amount of the credit allowed, if any, and notify the taxpayer to make the appropriate adjustment when the taxpayer files its income tax return.

(1) The statute of limitations for assessment of any amounts of potential tax attributable to the disallowance of a Paid Sick and Family Leave Credits under IRC 3131 and IRC 3132 claimed for qualified leave wages and the Employee Retention Credit under IRC 3134 will not expire until five years from the later of:

1. The date of filing of the original return that includes the calendar quarter in which the credit was claimed, or

2. The date the return is treated as filed under IRC 6501(b)(2).

(2) The extension of limitation on assessment applies to the Employee Retention Credit claimed for the third and fourth calendar quarters of 2021 under IRC 3134 but does not apply to the Employee Retention Credit under section 2301 of the CARES Act.

(3) The extension of limitation on assessment does not apply to other employment tax adjustments such as adjustments to fringe benefits or worker classification. The normal 3-year period of limitations applies to other issues.

(1) The CARES Act also contains a provision allowing employers to defer the deposit and payment of the employer's share of social security taxes from March 27, 2020, through December 31, 2020.

(2) On August 8, 2020, the President issued a Presidential Memorandum directing Treasury to use IRC 7508A authority to defer the withholding, deposit, and payment of certain payroll tax obligations. Notice 2020-65, 2020-38 I.R.B. 567, implements the Presidential Memorandum and provides guidance that allows employers to defer deposit of the employee share of FICA tax on compensation paid to an employee beginning on September 1, 2020, and ending on December 31, 2020, but only if the amount of the wages paid for a bi-weekly period were less than $4,000.

(3) For additional guidance on the Deferral of Social Security Tax, see IRM 21.7.2.8, Deferred Payment of Social Security Taxes for 2020.