September 2011 Archives

September 30, 2011
Posted by Michael Brooks

IRS Announces New Amnesty Program For Employers Who Have Improperly Classified Employees as Independent Contractors

In Announcement 2011-64, the IRS developed a new program to permit employer/ taxpayers to voluntarily reclassify workers as employees for employment tax purposes. And the penalty for compliance: a mere 10% of the employment tax liability that would have been due for the last year (plus the promise to the classify the individuals as employees going forward)!

Recall the importance of how an employer classifies its workers. Subject to a base limit, the compensation of every employee is subject to FICA taxes (commonly called social security taxes). Further, IRC Section 3102(a) requires employers to withhold FICA taxes from an employee's pay. If the employer fails to withhold the tax, it is still liable for payment of the tax. In addition, the employer must also pay a matching FICA tax equal to the employee portion of the tax. Lastly, a federal unemployment tax (FUTA ) is assessed on employers on all "wages" paid in a calendar quarter, although frequently employers never actually pay federal unemployment taxes due to credits they receive for payment of state unemployment taxes. An independent contractor (or self-employed person), on the other hand, pays for his or her own social security in the form of self-employment taxes (SECA). A self-employed person pays an amount equal to the employee portion plus the employer portion of employment taxes.

Who's an employee and who's an independent contractor? It comes down to a review of factors, including:

(1) the degree of control exercised by the principal;
(2) which party invests in the work facilities used by the worker;
(3) the opportunity of the individual for profit or loss;
(4) whether the principal can discharge the individual;
(5) whether the work is part of the principal's regular business;
(6) the permanency of the relationship;
(7) whether the worker is paid by the job or by the time;
(8) the relationship the parties believed they were creating; and
(9) the provision of employee benefits.

To be eligible for the program, called the Voluntary Classification Settlement Program ("VCSP"), an employer must: (1) consistently have treated the workers in the past as nonemployees; (2) have filed all required Forms 1099 for the workers for the previous three years; and (3) not currently be under audit by the IRS, the Department of Labor or a state agency concerning the classification of these workers. No interest or penalties will be due (there will be the 10% employment tax liability for the previous year), and the employers will not be audited on payroll taxes related to these workers for prior years. Participating employers will, for the first three years under the program, be subject to a special six-year statute of limitations, rather than the usual three years that generally applies to payroll taxes. The IRS retains discretion whether to accept a taxpayer's application under the VCSP. Taxpayers whose application has been accepted will enter into a closing agreement with the IRS.

September 27, 2011
Posted by Michael Brooks

Canadians Doing Business May Pay Tax As If They Were US Citizens

Let's stay with the effectively connected to a US trade or business concept discussed in the previous post. As discussed in the previous post, there exists very little guidance as to what it means to be engaged in a US trade or business. If a nonresident alien makes sales within the US, this may be considered a US trade or business. A nonresident alien may be considered to have a US trade or business if the nonresident has employees or agents who regularly travel to the US to make sales visits, or if he employs employees who make presentations in the US, or generally solicit business in the US.

Corporations are more likely to be considered doing business in the US if they have a "permanent establishment" in the United States. The term "permanent establishment" includes:
(a) a place of management;
(b) a branch;
(c) an office;
(d) a factory;
(e) a workshop; and
(f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.
A Canadian corporation may also be deemed to have a US permanent establishment if it performs services in the US through an individual present in the US for 183 days or more in any 12-month period for one project or a series of connected projects for US customers.

Canadian individuals who conduct business in connection with a "fixed base" may also be subject to US effectively connected income tax. For example, a Canadian doctor using a US hospital's examining room once a week to examine patients might be considered to be conducting business in connection with a US fixed base.

Tax Implications of Effectively Connected
If the Canadian citizen is engaged in a US trade or business, the individual is taxed by the US on the income which is effectively connected with the US trade or business. The effectively connected US income is taxed in the same manner as business income of a US citizen-resident (i.e., standard ordinary US income rates (currently 35% maximum federal rate for an individual). This is an ongoing test, which means that the conducting of a US trade or business at any time during the year will subject the taxpayer to US taxation. However, the Canadian citizen engaged in a US trade or business can also claim normal deductions which would typically be available to the US taxpayer. More importantly, Canadians doing business in the United States may not be liable for tax in both Canada and the United States, because the US-Canada Tax Treaty will likely remove the double tax via the credit system (to be discussed in a later post).

Don't Forget About California State Tax
Canadian citizens doing business in California also have to consider California tax issues that may arise as a result of their "nexus" to the state of California. As a general matter, states are not bound United States tax treaties, so the California state may tax may not be alleviated by the US-Canada Tax Treaty. We will discuss California state issues in detail in future posts.