Both the IRS and the Mass. Department of Revenue (DOR) plan on aggressively flushing out underground businesses in the years to come. Governor Deval Patrick recently signed Executive Order #499 Establishing a Joint Economic Tax Force on the Underground Economy and Employee Misclassification. See the full text at: http://www.mass.gov/Agov3/docs/Executive%20Orders/executive_order_499.pdf .
The DOR will be working with other state agencies such as the Department of Industrial Accidents, the AG’s Fair Labor Division, the Division of Occupational Safety, the Department of Public Safety and others. Their goal is to punish and penalize noncompliant business practices including:
· Paying bona fide employees “under the table” or on a 1099 basis instead of issuing W2 forms.
· Failing to provide Workers Compensation insurance benefits
· Wage and hour (overtime) violations
· Failing to collect and remit sales/meals taxes
An underground business targeted could face a multitude of taxes, penalties and sanctions including:
· Employment taxes (Social Security, Medicare, etc.)
· Unemployment taxes
· Sales/meals taxes
· Back pay awards and penalties
· Wage and hour penalties
· OSHA penalties
· Loss of professional license
Remember that even if you are not a business owner that underground businesses rob the Commonwealth and its taxpayers of desperately needed tax revenue. Think of this next time you drive over another pothole or worry about whether the bridge you are about to cross has been recently inspected or repaired. Moreover, by falsely classifying employees as “independent contractors” these businesses often deprive workers access health insurance, unemployment and retirement benefits, overtime pay and even workers compensation coverage.
This year I turned away two small businesses that wanted me to fudge the numbers on their business return. There are a few myths regarding businesses that I’d like to clear up here:
Myth #1: “Everything is deductible as long as you pay for it with a business check”
In order for any expense to be considered a valid business deduction it must be both “ordinary” and “necessary” for the business. For example, if your children are on your cell phone’s family plan, the cost of their lines is a non-deductible personal expense.
Myth #2: “If they pay me in cash the IRS will never know about it so there is no reason to declare it”
This couldn’t be further from the truth. The IRS and DOR have years of data available to them to recreate business income if it suspects a taxpayer is underreporting it. I’ve seen agents reconstruct a bar’s liquor income by subpoenaing invoices from the restaurant’s vendors. Agents can also look at a taxpayer’s lifestyle (what kind of house she lives in, what kind of car he drives, etc.) and wonder, “how does this couple live like this on $18,000/year?”
Myth #3 “If I pay my guys in cash no one is ever going to know or care”
Someone will care eventually… the employee may need to document his income for a mortgage (which is very important in the post-subprime scandal times we are in). Or the employee may try to collect unemployment benefits and rat out the business to the Division of Unemployment and Training (who refers the matter to the state DOR who in turn notifies the IRS).
What happens if the employee gets hurt on the job and the business doesn’t have workers compensation insurance? The penalties for not formalizing your payroll can not only put you out of business but can follow any person the IRS considers a “responsible party”.
Myth #4 “My business is so small the DOR won’t care if I file/pay sales/meals tax returns”
The DOR recently hired another 87 auditors and they are not fooling around. Any business, no matter how small can be scrutinized and they can go back as many years as they want if returns were not filed (though most will stick to 6 years). Also, payment for assessed trustee taxes (such as sales, meals and withholding taxes) become the personal responsibility of the owner or business manager in the event the businesses cannot pay.
Myth #5 “It’s not a big deal…if I get caught I’ll just pay up”
Willful tax evasion is a felony and the unpaid tax plus penalties and interest can ruin a business owner.
Federal penalties include:
· Failure to file penalty 25%
· Fraudulent failure to file penalty 75%
· Failure to pay tax penalty 25%
· Accuracy-related penalty (negligence or willful understatement of tax) 20%
· Fraud penalty 75%
· Tax evasion up to $500,000 and/or 5 years in jail
· Perjury and fraud up to $500,000 and/or 3 years in jail
Naturally, interest will be charged on the unpaid tax and penalties retroactively to the date the tax was originally due. Also, the information will most likely be forwarded to the Mass. DOR for assessment of state taxes, penalties and interest.
Myth #6 “Everybody does it”
No, they don’t – and by paying little or no taxes, paying less than the prevailing wage, hiring undocumented labor and/or cutting corners on insurance, licensing, etc. they can illegally underprice jobs at the Commonwealth’s and their competitor’s expense.
Whether you are already in business for yourself or are considering starting your own business, please feel free to call or email my office with any questions or concerns regarding your obligations as a taxpayer. I am glad to assist you.
