WHAT YOU NEED TO KNOW BEFORE YOU FILE IN 2015
BY KENDALL COLEMAN
The IRS is known for cyclical “crackdowns”: periodically selecting a particular rule or regulation and strictly enforcing it for a few tax cycles in order to reset the bar. Over the past few years the IRS has applied a laser-focus to a number of issues that directly affect construction: misclassified workers (independent contractor versus employee), I-9 violations, and most recently, fringe benefits.
WHAT IS A FRINGE BENEFIT?
A fringe benefit is an extra benefit that goes beyond an employee’s salary. A company car, reimbursed meals, reimbursed mileage – all of these common industry expenses are considered fringe benefits. While executives and managers typically see these reimbursements or “perks” as normal parts of business, according to the IRS some of these fringe benefits should be considered part of an employee’s income and are thus taxable.
It’s easy to be confused about which fringe benefits are taxable as compensation to the employee. For example, auto and fuel reimbursements are typically taxable to the employee. But, if the employer adopts an “accountable plan,” then many fringe benefits, such as auto, fuel and meal allowances, may be tax-free to the employee. An “accountable plan” essentially refers to the process of responsible expense reporting: the employee reports expenses incurred while performing services for the employer and the reimbursed amount must match the expenses reported. If not, the IRS will deem those reimbursements as taxable to the employee.
WHAT’S THE RISK OF ACCOUNTING FOR FRINGE BENEFITS INCORRECTLY?
The risk of misclassifying and failing to claim fringe benefits properly can be costly and time consuming, even if the total amount of the benefits isn’t a substantial amount. The IRS will re-characterize the fringe benefits as compensation, which will be subject to payroll taxes. The employer will receive a bill from the IRS for the employer’s match of payroll taxes, and the W-2s, W-3s and 941s will need to be amended by the employer. The employee will also have to amend his or her individual tax return. If an outsourced payroll company is involved, this process can be resource-intensive and expensive.
WHAT ABOUT 1099 EMPLOYEES WHO RECEIVE FRINGE BENEFITS?
If an employer issues fringe benefits to 1099 employees, there’s a greater likelihood that those benefits will be misclassified. Typically, the employer provides payment for fringe benefits in a separate check — not with payroll. As a result, the payroll department is not aware of the payment when time comes to prepare the W-2s and 941s and omits the payment from the payroll filings. In an effort to be compliant, many employers will issue the employees a separate 1099 for the value of the benefit. The IRS will consider the reimbursement to be a “nonaccountable” benefit, and will re-characterize the benefit under the W-2 rules for compensation. To avoid this problem, employers should include reimbursements with payroll or ensure that their payroll department includes any additional fringe benefit payments with payroll filings.
THE BEST APPROACH
Accurate, organized record keeping is essential for any employer that doles out fringe benefits or perks.
Keeping receipts is not enough. Employees must keep detailed records of “who, what, when, where, and how much.” For example, for mileage, employees should keep track of whom they traveled to see, what they did (or the purpose of the trip), when they went, where they went, and how much they spent. These records will ensure that both employees and employers are prepared for a potential audit and have the proper documentation to substantiate any deductions.
Because the accuracy and detail of records is paramount, employees should submit expense reports promptly and frequently. Weekly expense reports, for example, are much more likely to be accurate and complete, while quarterly reports will typically be prepared at the last minute and fail to include important details.
While automated apps like Concur make expense reports a breeze, it’s best to choose a method that is most likely to be used. In some construction firms, an app that can be quickly accessed via smartphone may be a great solution, but in other companies a traditional paper expense report may be more effective. Each company is different, so employers should pick a method that’s appropriate for their team and be consistent.
If the IRS performs an audit, they may request documentation on fringe benefits for the past three years. In many cases, simply supplying the proper documentation will be the first and final step of the audit. Employers should keep records in an easily accessible, thoroughly organized file or e-file for at least three years so they’ll be prepared to comply with any request.
Ensuring that fringe benefits are documented and accounted for correctly should be a priority for employers and employees in the construction industry, as the IRS is showing no indication of decelerating its strict enforcement. A tax professional and licensed CPA with experience in the construction industry can answer questions and help you make adjustments for total compliance with the IRS’s standards.
Kendall Coleman joined CST Group in 2001 and has more than 15 years of experience in accounting. He specializes in issues that concern closely held businesses, providing advice on accounting, taxation, and business planning issues to professional service providers, real estate firms, construction companies, and government contractors. Additionally, he has extensive experience in strategic planning for both multi-entity structures and high-net-worth individuals on federal and state income tax matters.