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[ Audit System Manual- TOC ] [ Ch 1 - Introduction ] [ Ch 2 - Preparing for an Audit ] [ Ch 3 - Conducting the Audit ] [ Ch 4 - Completing the Audit Forms and Schedules ] [ Ch 5 - Audit System Screens ] [ Ch 6 - Miscellaneous ] [ Ch 7 - USDOL - Tax Performance System ] [ Ch 8 - Computer Fundamentals & Hardware ] [ Appendix ]
[ 2.1 - Wages ] [ 2.2 - Payments Excluded from Wages ] [ 2.3 - Employer Payments ] [ 2.4 - Pre-Audit Areas of Review ] [ 2.5 - Assignment Preparation ] [ 2.6 - Audit Letter and Pre-Audit Questionnaire ] [ 2.7 - Verbal Notice of Audit ] [ 2.8 - Appointments ] [ 2.9 - Pre-Audit Interview ]

Chapter 2:    Preparing For An Audit

comments to: Tax Department

2.4    Pre-Audit Areas of Review

The items below give an idea of areas to review in specific industries before beginning an audit.

  1. Automobile dealers: It is an accepted practice for dealers to give a finder's fee to individuals for bringing in customers. An isolated payment to one individual is normally not wages; however, repeated payments to the same person might be wages and must be checked by the Auditor. A finder's fee paid to an acknowledged employee is wages. The employment status of "Car Shuttlers" should be examined.

  2. Attorneys, Doctors: Doctors and lawyers frequently have expense sharing arrangements, where only certain expenses are divided. An account should be established for each participant unless the parties have entered into some other type of legal entity. Office staff is occasionally listed as "contract labor".

    Physician (Doctors) – Employment by hospitals: In Texas, Occupational Codes, section 155.001 is written so that only a Physician/Doctor can hold a license to practice medicine, where as hospital can’t have this license; therefore a Physician/Doctor can’t be an employee of a hospital. Section 151.055 goes on to state that this subtitle does not prohibit a hospital from entering into an independent contractor agreement with a physician to provide services at the hospital.

  3. Banks: Director fees paid to acknowledged employees or paid to corporate officers who are also employees, are wages. Director fees and reasonable travel expenses paid to outside directors are not wages. Miscellaneous expenses should be checked for part-time guards, custodial or maintenance help, and bonus payments to employees.

  4. Cartage Companies: Drivers reimbursed expenses for labor to load or unload the vehicle would be wages paid by the company to the laborers through the driver as an agent. These wages may have to be reported as miscellaneous or unidentified wages if the names and social security numbers of laborers are not available.

  5. Corporations with common control: If personnel used by one entity also perform services for another entity and there is a charge for service without a management fee, it would constitute wages as if paid by the corporation for which the service was performed.
    Example: Corporation A loans staff to Corporation B, Corporation A issues the payroll and charges Corporation B for the gross wages plus social security and any fringe benefits. Corporation B reimburses Corporation A for that exact amount. Therefore, Corporation B should report the workers.

  6. Dental Workers:

  7. Domestic: Workers in a private home who provide services pertaining to the upkeep of the house, grounds, or its members are in domestic employment. This includes a health care worker, baby sitter, maid, butler, gardener, chauffeur, housekeeper, governess, nanny, waiter, handyman, etc. Since 1978, domestic workers were considered in employment if the employer paid as much as $1,000 in CASH wages in a calendar quarter. Payments by the employer to cover the employee's portion of social security are excluded from wages.

  8. Department stores: Department stores, grocery stores, and other entities using off duty police officers or security guards may not report these individuals as employees. This type of worker should be discussed with the employer and picked up if determined to be an employee of the entity.

  9. Eating and drinking establishments:
  1. Tips: Reporting For Federal Income Tax Purposes - All tips reported by an employee to their employer are required to be reported to the IRS as income to the employee. Federal wage reports and federal income tax information must show all wages paid by the employer, plus all tips the employees reported receiving.

    Allocated Tips is a term used by the Internal Revenue Service to indicate an estimate of the amount of tips that an employer should report for all employees (at least 8% of total sales). If the federal reports show less tip income than the Allocated Tip amount, additional income (for federal income tax purposes) is attributed to the employee.

  2. Tips: Reporting For State Unemployment Insurance Purposes - All reported tips and all wages paid by an employer are required to be reported as gross wages for state UI purposes.

    The current state minimum hourly rate, $7.25 per hour, is the same as the federal minimum wage amount. For state UI purposes, Texas eating and drinking establishments may use an employee’s reported tips to make up a portion of the minimum wage amount of $7.25 per hour. These employers must pay their employees at least $2.13 per hour, plus all reported tips. If the reported tips do not make up the difference between $2.13 per hour and the legal minimum hourly rate of $7.25 per hour, the employer must make up the difference, and report paying the employee $7.25 per hour on the Texas quarterly UI reports. Reported tips may make the hourly rate greater than $7.25 per hour, but not less than $7.25.

  3. Meals: When auditing eating and drinking establishments, the Auditor should determine if the employer furnished meals to employees. If so, the value of the meals are additional wages to the employee. Whether this is a convenience for the employer is not material.
  1. Farms and Ranches: A farmer may have more than one type of farm, such as a truck farm and a vineyard. The farmer may also have migrant, seasonal, and full time employees working simultaneously. The Auditor must know the differences between these categories of farm workers, and how each affects the reporting requirements for the farmer. Crew leaders will sometimes supply agricultural workers for a farm or a ranch, and in those cases, the crew leader is the employer.

  2. General contractors (construction): A contractor may have clean-up crews and substantial "contract labor" that should be reported as employees. A general contractor may also sub-contract some of the construction work by hiring independent businesses to do part of the work. Each case must be carefully reviewed.

  3. Gifts: Employers often give their employees gifts at certain times during the year - especially Christmas and fiscal year end - and they are taxable. Gifts may take the form of personal items, food, clothing, jewelry, or cash. Bonuses would be taxable, since they are usually determined based upon services rendered.

  4. Health Care Workers: For LVN, CNA, RN, Nurses, etc., – see Nursing; for Dental Hygienist, Dental Assistants, etc. - see Dental Workers.

  5. LLC - Limited Liability Company: Amounts paid to members, managers, or officers for personal services are wages. A profit distribution per some specified formula is not wages. An LLC must be registered with the Secretary of State. Reference: Tax Law Manual, Chapter 1 – "Limited Liabilities Company" for additional.

  6. LLP - Limited Liability Partnership: This entity type allows a partner to be sued by his own clients, but not his partner’s clients.  Partner draws are not wages.  Exception:  If the partnership/LLP elects to be taxed as a corporation meaning they owe FUTA taxes on the partner’s wages, those individuals would then be considered corporate offices for FUTA and TWC purposes.   See the information about Partnerships that follows.  An LLP must be registered with the Secretary of State.  Reference: Tax Law Manual, Chapter 1 – "Limited Liability Partnership" and Chapter 2 – "Payments Made To a Partner" for additional information.

  7. Manufacturing Companies: Bonuses, merchandise, trips, gifts, safety awards, employee of the month awards, etc. given to employees are wages.

  8. Military Differential Pay: This situation may be more commonly found in audits as employers may have individual now in service to the US military.  This payment is made by an employer and is the difference between their military pay and the salary paid by the employer.  These payments are made to an individual who been called up or voluntarily enlisted for active duty in the military for periods exceeding 30 days.  There are no services provided to the employer while this individual is on active duty and the differential pay is not subject to TUCA. 

  9. Motels, hotels, funeral homes, nursing homes: The market value of rooms and apartments, or any other type of free lodging or subsistence provided to workers is wages. Whether this is convenient for the employer is not material. Examine the records to determine if part-time drivers and security guards are properly reported.

  10. Multi-state employment: Employers may have business locations in more than one state. The employer may have reported the employees to the wrong state, failed to adjust for the difference in taxable wages between states, or failed to take into account wages paid to another state when an employee moves to Texas.

  11. Nursing:

  12. Oil and gas companies: These companies normally have consultants, however the Auditor should watch for individuals who were previously employees. Look for employees who retired or were laid off, and then subsequently rehired as consultants. The Auditor may need to review employment contracts in order to make a decision about employment. Also watch for contract labor, fees paid, and outside services.

  13. Partnerships: A partnership may be a general partnership, a limited partnership, or a limited liability partnership (LLP). Amounts paid to a partner in any of these partnerships are excluded from wages. When determining other people whose wages may be exempt, the Auditor must first determine the relationship between the partners. To be exempt, a worker must be related to all partners, for example:

Exception: If the partnership/LLP elects to be taxed as a corporation meaning they owe FUTA taxes on the partner’s wages, those individuals would then be considered corporate offices for FUTA and TWC purposes.

Reference: Tax Law Manual, Chapter 1 – "General Partnership" and Chapter 2 – "Payments Made to a Partner" for additional information.

  1. Payrolling: Sometimes referred to as "common paymaster". Payrolling, or common paymaster, is a situation where two or more legal entities combine their employees for reporting purposes and submit only one quarterly tax report. Texas UI tax law does not allow separate entities to combine their wage information on the quarterly reports. Each legal entity must report its own employees separate and apart from all other entities.

    References: Tax Law Manual – Chapter 4 - "Payrolling or Common Paymaster" or Status Manual, Chapter 6 - "Common Paymaster or Payrolling" for additional information.

  2. Real estate brokers: Real estate salesmen are exempt if they work for a real estate broker or real estate development company, and they are remunerated solely by way of commissions.

  3. Retail establishments: The value of merchandise, prizes, commissions, and bonuses are wages. Employee discounts are not deemed to be taxable.

  4. Sole proprietorships: When a business is owned by an individual it is important to remember that some relatives are not reportable. For example: spouse, mother, father, or children and stepchildren under the age of 21.

  5. Subchapter S Corporations: Small corporations may elect under the terms of Subchapter "S" of the Internal Revenue Code to be taxed for federal income tax purposes in a manner similar to a partnership. The corporation files an informational federal income tax return, and the profits are passed through to the shareholders of the corporation. A close examination should be made to determine if payments made to officers are dividends, or whether they are wages paid by the corporation for personal services provided by the individual. In these investigations, it is necessary to keep in mind that profits must be distributed to the stockholders in proportion to their ownership percentage. A deviation from that percentage could be wages. A review of the corporate minutes may be of assistance to the Auditor.

    Reference: Tax Law Manual, Chapter 1 – "Subchapter S Corporations" for additional information.

  6. Trucking companies: In general, the problems encountered in auditing trucking companies relate to alleged independent contractors. When dealing with trucking firms it may be important to determine such information as:
  1. Unions: Payments for services are treated as if paid by any other employer. Reimbursement for "lost time" paid to union members constitutes wages. Payments from a "Strike Fund" for picketing are not considered wages. If payments are the result of a court ordered National Labor Relations Board (NLRB) back pay award, there is the possibility the payments are not wages from the union.
  1. Vocational Education Students: Students working for an employer under a VOE program are not taxable. However, the employer is required to maintain a contract with the school providing the student. A student may not be under a VOE contract if they work during the summer, and the wages would be reportable. The workers must be full time students to qualify for VOE.
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Texas Workforce Commission  |  Unemployment Tax

Last Revision: May 05, 2011