Employer files wrong return - SOL not triggered.

One of the Service's favorite issues to raise in the course of an examination is that of worker classification (i.e., employee versus independent contractor status). Companies found to have misclassified workers can be held liable for the employment taxes that should have been withheld. It is therefore critical that taxpayers file the appropriate returns to start the three-year statute of limitations (SOL) period of Sec. 6501(a) for assessing employment taxes. Filing Forms 1099-MISC to report payments to workers classified as independent contractors was recently held insufficient to begin this three-year period (Ginter, DC Mo., 1993). According to the court, the three-year SOL began only when the taxpayer filed Form 941, Employer's Quarterly Federal Tax Return, which was not done in this case.

In Ginter, the taxpayer operated a sole proprietorship and classified his workers as independent contractors. He did not pay or withhold employment taxes on these workers, and did not file Forms W-2 or Forms 941. He did, however, file Forms 1099-MISC reflecting the payments made as nonemployee compensation. On audit, the IRS found t e workers to be employees, an taxes and penalties.

The taxpayer asserted that filing Forms 1099-MISC triggered the running of the three-year SOL and, thus, the Service was barred from making an assessment. The IRS disagreed, arguing that since the workers were employees, the taxpayer should have filed Forms 941. Thus, because the taxpayer filed the "wrong" returns, the SOL had not begun to run.

The court concluded that the key to determining whether a wrong return can trigger the start of the limitations period was whether the information provided was sufficient to allow an IRS agent reviewing the return to determine how much tax was due. The court found the information provided on the Forms 1099-MISC filed by the taxpayer to be insufficient. It was not evident from the forms that his workers were employees; in fact, filing those forms instead of a Form 941 was a representation to the Service that those workers were not employees. Therefore, the SOL had never been triggered.

Note that a failure to trigger the SOL under Sec. 6501(a) will occur only in cases in which the company does not treat any workers as employees (and thus does not file Form 941). Typically, this will arise when a sole proprietorship is involved or when a corporation's employees are "housed" in a related corporation.