In the current economic climate, small business owners are trying to make ends meet and are cutting corners wherever they can. Unfortunately, some of the cuts they make may not be legal and they may not even know it. When caught by the IRS, they may rush to point the finger at anyone they can in order to avoid paying penalties and interest. While you cannot give “legal” advice to your clients, you should school your employees on warning signs that your clients might not be on the up-and-up when processing their payroll. You may help a client from unintentionally breaking the law, but you will certainly prevent a naughty client from being able to say “You never told me…”
Employees being converted to salary — This is probably the oldest one in the book. In order to avoid paying out a lot of overtime, employees are converted to salary. It has also been the cause of many class-action lawsuits. The rules for employee exempt versus non-exempt classification are also not very cut and dry. If you suspect that employees are being converted to salary to save money and not just because the employees’ positions have changed, find a gentle way to bring up the fact the the IRS is on the lookout for mis-classified employees right now. Rather than advising the client, direct them to the U.S. Department of Labor or a source of information in the client’s home state, such as the following link for the California Department of Industrial Relations. When in doubt, the client should always seek advise from legal counsel when determining how to properly classify an employee.
Employees being converted to 1099 status — This is a variation on the point above. If you notice employees that had been standard hourly or salary employees being converted to 1099 status, this should send up a red flag. It could be legitimate, the business could have changed policies allowing employees to telecommute and thus making it more likely that they are true “independent” contractors. However, it certainly should warrant probing questions about any changes that the client has made in his business model. In a service-based environment, you should have a good enough relationship with your client to be able to show interest in his business. If you suspect he may have misclassified employees, I also suggest you send him directly to the IRS for information. Much like the rules for classification of exempt employees, the rules for independent contractors are also not very cut and dry. Please have your client seek legal counsel if he has any further questions.
Clients processing a lot of voucher checks — If your client begins processing vouchers in lieu of standard payroll or begins processing many more vouchers than normal, this could be an indication that employees are being paid “under the table”, and that payroll taxes are not being withheld. You can remark that you notice more vouchers are being processed as of late, or even ask why. If you suspect that employees may be receiving cash or under the table wages, it might be good idea to direct the client to the IRS for more information.
IRS examples of Tax Fraud — It can be challenging to bring topics such as this to a client’s attention because you don’t want to offend your clients. Your clients have hired you for your payroll expertise and expect you to keep them compliant. I suggest pointing out that in recent years, the IRS and other taxing authorities have stepped up investigation and prosecution efforts into businesses that may not be compliant with payroll tax compliance laws, point them to an IRS link with additional information and just ask that they be careful.
If you approach the subject as a trusted adviser, letting them know that taxing authorities are very strict in this economy and you don’t want to see them investigated or penalized, most clients will appreciate the thought.