Employment Dept audits are on the rise

There has been an increase in the number of Employment Dept. audits as cash-strapped agencies are looking for tax revenue “opportunities.”

If your business receives an audit notice, you may be wondering what, if anything, you did wrong.  According to Employment Department auditors, there are 3 reasons a small business may be targeted for audit:

  1. Your business has been audited by another agency, such as IRS, L&I/Workers Comp. agency or Dept. of Revenue and have been determined to be out of compliance.  Government agencies share information with each other, so an audit-gone-bad with one agency is likely to spark more audits with other agencies.  The best way to avoid this is to run a squeaky-clean operation and avoid the first bad audit.
  2. You have 1099 contractors or you are in an industry that is notorious for incorrectly classifying employees as 1099 contractors.  The Employment Dept will want to make sure that you are paying your fair share of Employment taxes (SUTA) by ensuring that your contractors are legitimate contractors and employees are classified as employees.
  3. You have been randomly selected for an audit regardless of your practices or industry.

If you get an audit notice, here is how to prepare for an audit:

You will be asked to produce employment, payroll and various financial records, to prove everything is being done by the book.

  • Take the time to gather all requested documentation and have it readily available, correctly filled out, and up-to-date.
  • Be able to demonstrate that your 1099 contractors really are legitimate contractors (i.e. they are running their own legitimate businesses).
  • Make sure all your employee documentation is complete and readily available (W-4, W-9, I-9, etc.).
  • Make sure your bookkeeping and tax returns are up-to-date and in order.

The main red flag is independent contractors who are not paid as employees, but whose pay is being reported on a 1099-MISC form.  If you have 1099 contractors, make sure they are not actually misclassified employees. The litmus test is whether they are running a bona fide business.

If the Employment Department disagrees with your classification, you can be made to pay back taxes going back 3 years, plus penalty and interest!!!