Audit Pitfalls

1. Audit Pitfalls Jason E. Russell Deloitte Tax LLP October 6, 2016 115p

2. Agenda • Non-cash Fringe Benefits • U.S. Payroll Deposit Rules & Equity Transactions • Service Provider Documentation • Worker Classification & Settlement Program

3. Fringe Benefits • Awards and prizes • Gift cards • Ipod, ipad, raffle prizes • Award trips • “President’s Club, Diamond Club, Century Club” • Spousal accompaniment on award trips • Loans • Date of hire payments: is forgiveness planned? • Company cafeteria • Subsidy (reduced price) is OK; free is not OK • Wellness program cash-equivalent incentives • Subsidized gym dues • Relocation • Househunting trips are taxable • Commuting is taxable, even if done via flight • Employee discounts • 20% OK on services • Gross profit % OK on goods

4. Fringe benefits: Be cautious of these W-2 inclusion is correct for many of these • Awards and prizes • Gift cards • Ipod, ipad, raffle prizes • Award trips • “President’s Club, Diamond Club, Century Club” • Spousal accompaniment on award trips • Loans • Date of hire payments: is forgiveness planned? • Company cafeteria • Subsidy (reduced price) is OK; free is not OK • Wellness program cash-equivalent incentives • Subsidized gym dues • Relocation • Househunting trips are taxable • Commuting is taxable, even if done via flight • Employee discounts • 20% OK on services • Gross profit % OK on goods

5. Next (Business) Day Payroll Deposit Timing Deposits due the following Wednesday Particularly for equity transactions, but these apply to all payroll liability events Deposits due that Friday $100,000 Wed-Fri Sat-Tues

6. What’s the Payroll Liability Date? Depends on the Type of Equity Stock Options • Exercise date • See IRS Memo, which provides for transaction + 3 days to settle (up to that), and another day for the deposit to credit RSUs • Settlement date (net shares to participant accounts) • See also: theory behind IRS memo, even though language of memo only applies to stock options RSAs • Vesting date of the shares • Date of 83(b) election, if one is made 6

7. Field audit memorandum • On March 14, 2003, a Memorandum was issued by the IRS to audit examiners to provide guidelines surrounding assessment of employment tax penalties for NQSOs. • “It has been argued that the shares (or the value of the shares) are not available to the exerciser of the options until settlement date, and therefore no actual or constructive payment of wages takes place until that time. • There is generally only a three day delay between time of exercise and time of settlement resulting from such exercise. In fact, under 17 C.F.R. Sec. 240.15c6-1(a), the SEC generally established a maximum three day settlement period for broker- dealer trades. There is presently no specific published guidance relative to whether the date of exercise or date of settlement is the appropriate date for considering assertion of the penalty for failure to deposit employment taxes attributable to the exercise of nonqualified stock options.” • Under this Field Directive, auditors “should not challenge the timeliness of deposits required under Treas. Reg. § 31.6302-1(c), if such deposits are made within one day of the settlement date, as long as such settlement date does not fall more than three days from date of exercise.” 7

8. 1-5 days late Payroll Deposit Penalties 6-15 days late Based on calendar days, not business days More than 15 days late 2% 5% 10% 8

9. Penalties • The IRS uses a First In First Out system to assign deposits, and will attribute a deposit to the most recent tax liability, even if a deposit was missed and the deposit actually relates to a later-dated liability. Unfortunately, this can cause a cascading penalty. • Taxpayers can designate to which tax period they want a specific deposit applied within 90-days of receipt of a notice of penalty. • The IRS does allow a “safe-harbor” shortfall if the shortfall is no more then the greater of $100 or 2% of the amount due, so long as the original deposit is made timely, and the shortfall is made up by the ‘make-up date.’ • Example: A is required to make a deposit of $1,000 on June 15 and is a semi-weekly depositor. A makes a deposit of $900 on June 15 and would be required to make the additional $100 deposit by the first Wednesday or Friday occurring on our after July 15th. Because the shortfall is $100 and they have made up the deposit by the make-up date, no penalties are assessed. 9

10. Domestic Business Travelers • Which jurisdictions are the most active in audit of non-local companies? WA ME MT ND VT MN OR NH ID SD MA WI NY MI CT WY RI IA PA NJ NE NV MD OH IL IN DE DC UT WV CO CA VA KS MO KY NC TN OK AZ NM SC AR GA AL MS LA TX AK FL HI

11. Non-US service providers • Employee v. Contractor • Treaty Considerations (Dependent v. Independent personal services) • Totalization agreements for social taxes • Certification of non-US status • Form 8233 • W-9 • W-8BEN XX%Supporting text or key insight runs here

12. Service Provider Documentation Requiring proof of this is a recurring audit topic for the IRS • Used to support US taxpaying vendor providing services in the US. • Technically, original W-9 not required at vendor setup, contract initiation (except for interest, dividends • Upon receipt of taxpayer ID mismatch from the IRS, original “wet signature” W-9 should be provided to you by the service provider. Backup withholding should begin between notice by the IRS of mismatch and the provision of updated information. Form W-9 Form W-8BEN • This is often provided by non-resident contractors performing services in the US • Supports 1042-S reporting Form 8233 • Non-US resident contractors performing services in the US • Provides reduced or no withholding on the income provided to them. • Annual form • Supports 1042-S reporting 12

13. Confirming the payee status • Must provide a certified TIN for payments of interest, dividends or other payments that are subject to broker reporting, and after receipt of B notice • For all other payments, the TIN may be provided in any manner. Verbal is acceptable in some cases, however, a log of these calls is required to be maintained • Payer may require a signed form W-9 from U.S. exempt recipients to overcome a presumption of foreign status • Non U.S. recipients would not provide a Form W-9, but instead provide a Forms W-8 or Form 8233 • Disregarded entity: provide name/TIN that would be on tax return Obtain documentation (e.g., Form W-9, Forms W-8 or Form 8233) from payee to determine their residency status. You may rely on representations on the statement unless form is invalid on its face or you have knowledge or reason to know the form is incorrect Best Practice is to always request a signed tax form 13

14. Form W-8BEN: Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals) Purpose • Establish foreign status • To claim a reduced rate of, or exemption from, withholding tax as a resident of a foreign country with which the United States has an income tax treaty • Claim status as the beneficial owner of the income for which the form is being furnished • Claim exemption from Form 1099 reporting and backup withholding for income that is not subject to NRA withholding Who and When • A foreign individual that is a beneficial owner of income should provide Form W-8BEN to the withholding agent or payor • This form should be provided at least every three years by the payee • This form should be updated within 30 days of a change in circumstances or address Validity Period • Generally, a Form W-8BEN provided without a U.S. TIN will remain in effect for a period starting on the date the form is signed and ending on the last day of the third succeeding calendar year, unless a change in circumstances makes information on the form incorrect

15. Form 8233 - Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual. Used most commonly by NRA independent contractors to obtain reduced withholding Purpose • Establish foreign status for independent services (e.g. non-U.S. independent contractor working in the U.S.) • To claim a reduced rate of, or exemption from, withholding tax as a resident of a foreign country with which the United States has an income tax treaty Who and When • A foreign individual that is a beneficial owner of independent personal services income • This form should be provided every year by the payee • This form should be filed with the IRS

16. Form W-8BEN-E: Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities) Purpose • Establish foreign status • To claim a reduced rate of, or exemption from, withholding tax as a resident of a foreign country with which the United States has an income tax treaty • Claim status as the beneficial owner of the income for which the form is being furnished • Claim exemption from Form 1099 reporting and backup withholding for income that is not subject to NRA withholding • Certify FATCA classification (to be addressed in next section) Who and When • A foreign entity that is a beneficial owner of income should provide Form W-8BEN to the withholding agent or payor • This form should be provided at least every three years by the payee • This form should be updated within 30 days of a change in circumstances or address Validity Period • Generally, a Form W-8BEN provided without a U.S. TIN will remain in effect for a period starting on the date the form is signed and ending on the last day of the third succeeding calendar year, unless a change in circumstances makes information on the form incorrect

17. Common misconceptions of worker classification • Project workers are not employees • Temporary workers are not employees • Former executives returning as “consultants” are independent contractors 17

18. Rev. Rul. 87-41 — Twenty common law factors • Instructions • Training • Integration • Personal services • Hire, pay assistants • Continuing relations • Set work hours • Full time required • Employer’s premises • Order, sequence set • Oral, written report • Hour, week, month pay • Business expense pay • Furnish tools and materials • Significant investment • Realize profit, loss • More than one employer • Services available to public • Right to discharge • Right to terminate 18

19. IRS 2006 audit manual on worker classification • Created 3 categories of evidence: • Behavioral control • Financial control • Relationship of the parties 19

20. Worker classification “Red flags” • Former employees • Form 1099 & Form W-2 • Form 1099 – Multiple years • Industry focus • Leads • IRS internal database • Contractor originated • State info sharing 20

21. Facts & Circumstances Considerations • Is there a web presence for the contractor? • Does 100% of work come from single source? • Who pays any assistants? The contractor directly or the company? • Paid hourly or by the job? • Expenses paid separately or part of the overall fee? 21

22. Tax rate comparison 22

23. Voluntary worker classification settlement program • A program that allows employers to resolve past worker classification issues at a reduced cost by voluntarily reclassifying their workers • Available to businesses, tax-exempt organizations and government entities that currently erroneously treat their workers as independent contractors, and may likely like to correctly treat them as employees in the future 23

24. Eligibility for Voluntary Program • To be eligible, an applicant must: • Consistently have treated the workers in the past as nonemployees • Have filed all required Forms 1099 for the workers for the previous three years • Not currently be under audit by the IRS, and not currently be under audit by the DOL or a state agency concerning the classification of these workers 24

25. Contact information Jason RussellManaging DirectorDeloitte Tax LLP+1 415.783.5376jasrussell@deloitte.com 25

26. This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation. 26

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