The private club industry is likely to see more 941/940 audits by the Internal Revenue Service (IRS). The IRS has recently trained agents who are specialized in 990/990T tax return audits on 941/940 audits. While no reason was given for this shift, the additional income as well as penalties and fines from tax errors on the 941/940 returns are greater than those of the 990/990T returns.
The IRS refers to the 941/940 audits as “compliance research examinations. While the IRS usually selects 941/940 returns for examination based on some indication the returns are incorrect, it also randomly selects returns. According to the IRS, the random selection of a return, while it does not mean the return contains errors, allows the IRS to collect information on how taxpayers meet their tax responsibilities. The IRS claims:
This information will help us determine what changes to IRS forms, publications and tax laws may improve voluntary compliance. It will also be used to guide improvements to how the tax laws are enforced, and to programs designed to help taxpayers understand and comply with the tax laws1.
In a recent examination of a club, in addition to requesting the 941 and 940 tax returns for a selected tax period, the IRS requested2:
- Forms W-2 and W-3
- Forms W-4 for all employees
- Copies of Forms 1096 and 1099
- Disbursement records
- General ledger
- Forms W-9
- Chart of Accounts
- Vendor Listing File
- Personnel manual, employee handbook
- Copies of written policies regarding accountable and non-accountable plans, auto, travel, meal and entertainment allowances/reimbursements, tuition reimbursement, cell phones, personal computers and life insurance over $50,000
- Copy of 125 Cafeteria Plan, if applicable
- Employment contracts
- Employee benefit packages
- Independent contractor contracts
- Board, Audit and Finance minutes
- Annual report and audited financial statements
If errors are found on the returns during the examination, the taxpayer is notified and given an opportunity to explain them. If tax was overpaid, a refund with interest will be granted. However, despite the IRS stating that this process is a research examination, if tax is due, payment plus penalties and interest will be requested.
The two biggest areas of concern for clubs are:
- Misclassification of employees as independent contractors and
- Taxable fringe benefits not being included on the employees’ W-2.
The first area of concern, misclassification of employees, will provide the IRS with the most potential for additional revenue and therefore will be a major focus. This will be very costly for a club found in violation, with additional back taxes plus penalties and interest. Also if the club has a 401k plan, there would be additional tax exposure.
The club has the right for outside representation during any part of the exam. Note that McGladrey can assist in navigating through document requests as well as the actual exam process, including addressing any IRS questions.
1Source: IRS – Notice 13332
2Source: Form 4565 – IRS Information Document Request
Susan Bobby is a manager with McGladrey, a leading provider of assurance, tax and consulting services. Susan has more than 17 years of professional accounting experience with a concentration on serving private country clubs, yacht clubs and common interest realty associations. Susan can be reached at [email protected]. This article first appeared in McGladrey eClubNews.