- IRS Audits Focusing On Staffing Agency per Diem
- April 8, 2014
- Law Firm: Kaufman Canoles A Professional Corporation - Norfolk Office
The last several years have seen an uptick in IRS audits regarding per diem reimbursement plans in the staffing industry after years of perceived abuses.
The IRS is focusing heavily on “wage recharacterization,” which the IRS defines as the practice of paying temporary employees higher wages when they don’t receive per diem payments, and lower wages when they do receive per diem. For example, a marine industrial project requires additional skilled labor for six months, so two workers-both employed by a staffing company-are staffed on the six-month job in Norfolk, performing the same type of work. One lives in Norfolk; the other lives in and travels from Georgia to take the six-month job in Norfolk. Typically, the Georgia worker is entitled to a tax-free per diem to account for lodging, meals, and incidental expenses incurred in traveling to Norfolk for the project. However, the IRS is identifying and auditing staffing agencies that pay the Norfolk worker a wage of, for instance, $20 per hour, with no per diem, but pay the Georgia worker a wage of $10 per hour with a $80 tax-free per diem. Note that, at the end of an 8-hour day, the Norfolk worker receives $160 in taxable wages, and the Georgia worker receives $80 in taxable wages and $80 in tax-free per diem. On audit, the IRS is attempting to reclassify the per diem payment as wages on the grounds that both workers should be paid the same wage, and any tax-free per diem should be in addition to that wage, not in lieu of it. If the IRS succeeds in its wage recharacterization argument, the employer would have to pay the Georgia worker’s income tax withholding, both sides of payroll tax, and penalties and interest for all open tax years. Additionally, if this “recharacterization” practice is widespread within the company, the IRS can use the so-called “pattern of abuse” regulations to reclassify all per diem payments made to all employees as wages, even if some per diem payments are completely acceptable.
The IRS is also looking at making sure employees’ “tax homes” are correctly identified by their employer. In other words, the employer must ensure the employee is working away from his true “tax home” before paying any per diem. The IRS is often challenging the sufficiency of employers’ documentation processes-for example, seeking current leases, mortgage statements, utility bills, etc.-to make sure an employee actually has a tax home away from where he’s working. Also, any “temporary” employees working in one location for longer than twelve months pose additional problems as they are no longer eligible to receive per diem while continuing to work in that location.
This issue has understandably been on the staffing industry’s radar lately given the potential for substantial liability if done incorrectly and caught on audit. The IRS is being very proactive about targeting the staffing industry regarding these practices, so ensuring compliance now will minimize liability.