Accounting & Bookkeeping & Small Business Forum

[trarob]

I have a client who has subcontractors for various jobs. The subcontractor also work on other projects not related to my client. My client is currently taking the total owed to the subcontractor and subtracting out the cell phone bill he pays for the subcontractor. The subcontractor does not use the cell phone for just my client's business. My client then claims the total charges for all the cell phones on his tax return which has raised a red flag with the IRS. I told my client that he should personally not pay the cell phone bill and have the subcontractors pay their share because they use it for more than just his company. He should only claim his portion of the cell phone on his taxes. Also he should not reduce the amount owed to the subcontractor. My questions are: 1. I'm I advising my client correctly. 2. How should I make the adjustments (should I file an amended return with the correct amounts for cell phone and send corrected 1099s to all the subcontractors with the higher amount) 3. Advise the subcontractors they should also file an amended with the higher income claim the cell phone expense. This client's files go back to 2005 in which we are looking to correct. I just acquired this client so I did not keep his books or do his taxes for prior years.

[RobJ]

trarob wrote: My client is currently taking the total owed to the subcontractor and subtracting out the cell phone bill he pays for the subcontractor. ... My client then claims the total charges for all the cell phones on his tax return ...
Personally, I'd be concerned that the IRS, during an audit, would reclassify the sub-contractor as an employee and get your client for back payroll taxes not to mention his insurance carrier going after him for worker's compensation premiums. There needs to be an "arms-length" relationship between your client and his sub-contractors. The relationship he currently has may be completely legitimate, but this example certainly makes it all seem rather suspect.

Rob

[trarob]

I agree with you. I mentioned that to him that he is treating his subcontractor like an employee and that would open him to other things which is why he has to get all years corrected and begin handling his subcontractors the right way.

[RobJ]

trarob wrote: ... which is why he has to get all years corrected and begin handling his subcontractors the right way.
This is just "my opinion" and certainly isn't in keeping with good morals and strong ethics. I'd let the prior years go and correct the situation for this year and the future. The SMOKING GUN here is whether your client can demonstrate that his relationship with those he hires is that of an employee or a sub-contractor. If it's with a sub-contractor, then amending those returns SHOULD not be a problem. However, if it's really with an employee, amending those returns could open a can of worms that won't be pleasant.

Option 1 - wait out the 1 to 3 years for the original returns to fade into the sunset hoping for the best.

Option 2 - if you're going to amend the returns, what else is in there that might create further problems? Keep in mind that amending the original return is a red flag in and of itself and opens the original return and the amended return up for scrutiny.

In either case, your client needs to get his act together regarding these relationships. As you know, it's VERY SERIOUS BUSINESS!

I wish you the best of luck.

Rob

[Richard Noot]

trarob wrote: I agree with you. I mentioned that to him that he is treating his subcontractor like an employee and that would open him to other things which is why he has to get all years corrected and begin handling his subcontractors the right way.

You say that he is treating his subcontractor like an employee?? NOT so. If he were an amployee he should be issuing a w2 for any cell phone use not related to his business. I also disagree with the other posters suggestion in leaving the situation alone. There is no statute of limitation when an employer fails to issue a w2. The only thing accomplised by not amending back years are larger penalties and interest and possible criminal charges for fraud.

[RobJ]

Richard Noot wrote: You say that he is treating his subcontractor like an employee?? NOT so. If he were an amployee he should be issuing a w2 for any cell phone use not related to his business.
If defining our relationships were as simple as issuing one form over another (1099 vs. W2), life would be easy and financially rewarding. The IRS has a funny way of viewing relationships and it's not determined based on whether a taxpayer issued a 1099 or a W2 - it's generally based on the facts, the personality of the taxpayer, and the personality of the revenue agent. There isn't enough information given about the relationship the OP has provided to make any kind of determination. Given that the OP is concerned, the example provided casts some doubt/concern about the definition of their relationship and related tax liabilities.

Richard Noot wrote: I also disagree with the other posters suggestion in leaving the situation alone. There is no statute of limitation when an employer fails to issue a w2. The only thing accomplised by not amending back years are larger penalties and interest and possible criminal charges for fraud.
First, in regard to fraud, the IRS has the burden of proof and the OP hasn't provided anything yet that rises above the level of misunderstanding, bad advice, or sheer stupidity.

Second, the IRS must prove fraud in order to audit and assess tax beyond the 3-year stopwatch.

Third, if the OP is concerned about fraud (and I'm not suggesting that there is any here) ... the ONLY prudent course is to find a good tax attorney!

Rob

[trarob]

I don't think there is fraud. I think it's about a person who enjoys just doing roofing type of work and allowed his wife to handle his books. All these years he has never actually consulted anyone about if things were being done right. When I met with him and begin talking to him about different things and how he should be tracking things etc. He was excited to just have someone who truly knew the field and could set him up correctly and organize things. He does have all documents and some organization to it as well the IRS Auditor was actually nice and helpful once he got in there and saw how my client easy provided the information and wasn't trying to skate around anything. My client is willing to pay the penalties/interest for any of the years that weren't filed correctly. He's more concerned with getting everything in line moving forward with things done right. One lesson learned that unexperienced family members aren't always the best to hire just because they are cheaper.

[Richard Noot]

RobJ wrote: Richard Noot wrote: You say that he is treating his subcontractor like an employee?? NOT so. If he were an amployee he should be issuing a w2 for any cell phone use not related to his business.
If defining our relationships were as simple as issuing one form over another (1099 vs. W2), life would be easy and financially rewarding. The IRS has a funny way of viewing relationships and it's not determined based on whether a taxpayer issued a 1099 or a W2 - it's generally based on the facts, the personality of the taxpayer, and the personality of the revenue agent. There isn't enough information given about the relationship the OP has provided to make any kind of determination. Given that the OP is concerned, the example provided casts some doubt/concern about the definition of their relationship and related tax liabilities.

Richard Noot wrote: I also disagree with the other posters suggestion in leaving the situation alone. There is no statute of limitation when an employer fails to issue a w2. The only thing accomplised by not amending back years are larger penalties and interest and possible criminal charges for fraud.
First, in regard to fraud, the IRS has the burden of proof and the OP hasn't provided anything yet that rises above the level of misunderstanding, bad advice, or sheer stupidity.

Second, the IRS must prove fraud in order to audit and assess tax beyond the 3-year stopwatch.

Third, if the OP is concerned about fraud (and I'm not suggesting that there is any here) ... the ONLY prudent course is to find a good tax attorney!

Rob Igtnorance is no excuse. As far as your suggestion that the ONLY option is to find a good tax attorney would it not be cheper just to fix the problem and do it right in the future?? Also your statement that the IRS has to prove fraud in order to audit and assess is not correct. There is no statute of limitation for not filing.

[Richard Noot]

trarob wrote: I don't think there is fraud. I think it's about a person who enjoys just doing roofing type of work and allowed his wife to handle his books. All these years he has never actually consulted anyone about if things were being done right. When I met with him and begin talking to him about different things and how he should be tracking things etc. He was excited to just have someone who truly knew the field and could set him up correctly and organize things. He does have all documents and some organization to it as well the IRS Auditor was actually nice and helpful once he got in there and saw how my client easy provided the information and wasn't trying to skate around anything. My client is willing to pay the penalties/interest for any of the years that weren't filed correctly. He's more concerned with getting everything in line moving forward with things done right. One lesson learned that unexperienced family members aren't always the best to hire just because they are cheaper. The burden of proof for fraud is on the IRS. I did not state that there was fraud only that it was a possibility. It all depends on the circumstances of the particular situation. However ignorance of the law is no excuse. The Irs can and will assess interest and penalties for non due dilligence.

[RobJ]

trarob wrote: He does have all documents and some organization to it as well the IRS Auditor was actually nice and helpful once he got in there and saw how my client easy provided the information and wasn't trying to skate around anything.
This is where limited information is a dangerous thing. You didn't mention that an IRS auditor is already involved. Your description of the situation very common.

1. I think you're advising your client correctly.

2. File the appropriate amended returns and corrected 1099's.

3. Let the sub-contractors take care of their own taxes. You may want to give them a heads-up that corrected 1099's are coming.

Tracia, I hope that we have provided you the guidance you were seeking.

Rob

[Ahshucks]

Your client has specified a payment direct to the subcontractor for the use of cell phones. Eliminate that, by replacing it with a contract premium, or performance bonus on one or all of the contracts awarded to the contractor. That runs the expense through COGS rather than telephone expense and won't be scrutinzed so closely by an auditor.

It may be a good practice to have your subcontractors fill out an SS-8 for your file: http://www.irs.gov/pub/irs-pdf/fss8.pdf