[ 4.7.1 - 1099s & 1096 ] [ 4.7.2 - Schedule Three Fields] [ 4.7.3 - Additional Information About Schedule Three]

A blank copy of Schedule 3 is located in the Appendix Section of this manual. 

During the audit investigation, the Accounts Examiner must search the employer's records for unreported wages. Misclassified workers and hidden wages are the most significant areas of noncompliance among registered employers. Documentation of the AE's search for hidden and misclassified wages occurs on Schedule 3.

Four different types of employer records must be examined -- records of contract labor, records of cash disbursements, ledgers and journals, and other miscellaneous reports and accounts. If the employer keeps the records deemed essential to conduct the audit, the Auditor must examine those records. If the employer maintains no records or only partial records, the Auditor must document that fact on Schedule 3.

There are some specific requirements for documenting the search for unreported wages:

If 1099’s are issued, ALL 1099's must be reviewed.  Sampling the 1099’s does not satisfy the search for unreported wages.  When documenting the review of the 1099’s, the Auditor may list them by groups, such as 15 1099’s were for purchase of grains, or 25 1099’s were for dividends or interest. 

Audit workpapers must document that ALL 1099’s issued were reviewed, this can be done by one of the following methods.

1. Reconciling the 1096 to the 1099's.
2. Including a copy of the 1099's/1096 with audit workpapers.
3. If the employer did not issue a 1096 document the facts and include a statement that all 1099's issued by employer were reviewed.

Reconciling 1099's to 1096: When the 1096 is reviewed the audit work papers must show that the 1099's equal the 1096 or explain the differences.  A comment in the 1096 entry or the other comments box such as “All 1099's reviewed and equals 1096” is sufficient.  Reference: The section titled Additional Information about Schedule 3 for additional information.

1099's and NEC assignments: The reviewer must be able to verify from the audit work papers that any 1099 amount which requires a NEC assignment is documented.  If none of the 1099's reviewed meet this requirement a comment in the 1096 or other comments box such as “No 1099 exceed $100,000” is sufficient.  Reference Procedures Manual Chapter 7 – "NEC – Non-Employee Compensation Assignments" for additional information.

1099's issued to entity other than an individual (Inc, PC, LLC, PLLC, Partnership, Association, etc.)

When an employer issues a 1099 to an entity other than an individual, the auditor should search for a TWC account number and document the number if found. If there is no TWC account number or the account has been inactive during the audit period an NEC assignment must be issued if the 1099 or payment is for more than established criteria. While 2 common law factors would be beneficial for an entity other than an individual without a TWC account number they are not required. This procedure assumes that the work was performed in Texas - if not then a simple comment about all work being performed outside of Texas will suffice. Use results code 1 and because TPS requires a comment - use "payment to an entity other an individual - no suspicion" as your justification.

1099's issued to an individual:

When an employer issues a 1099 to an individual the auditor should search for a TWC account number and document the number. If there is no TWC account number or the account was inactive during the audit period, the auditor must include at least 2 common law factors to justify the individual being classified as independent. Additionally, if the 1099 or payment is for more than established criteria an NEC assignment must be issued. This procedure assumes that the work was performed in Texas - if not then a simple comment about all work being performed outside of Texas will suffice.

EMPLOYER NAME	The employer's name, system entered.
AUDIT SCOPE	Enter audit period, i.e., 1/1/YY - 12/31/YY.  Program defaults to year selected by auditor, however audit scope can adjust as necessary.
ACCOUNT NUMBER	TWC employer's account number, system entered.
RECORD TYPES	Select the record type(s) reviewed during the search for additional wages.  At least one record type from each category of records must be examined for additional wages during the audit process.  The auditor must indicate if the employer did not maintain records in any specific record category.
BEGIN DATE & END DATE	Enter the date range of the record being reviewed.  For records that have an identifiable start and end date such as cancelled checks, check registers, detail general ledger, general ledger, etc., the start and end dates will be entered. For records that don’t have an identifiable starting and ending date such as 1099's, 1096, Federal Tax Return etc., enter the year ending date (12/31/YY) in the Begin Date column only. For single entry items such as cancelled checks, etc., added via Schedule 1, the start an end dates will be the same.
ACCT # / ID	Enter the transaction number of the record type.  Cancelled Checks: The beginning number and the ending number in the check series must be entered.   Detail General Ledger / General Ledger:  The account/categories names or accounts numbers examined, if known, must be entered. If the account sequence (alpha/numeric) can’t be readily identified the auditor will include a comment stating all accounts reviewed. If the account sequence (alpha/numeric) is too large for the payee/account description column enter that information in the comments cell.
VENDOR ID	Enter a vendor identification number or description when appropriate.
PAYEE/ACCOUNT DESCRIPTION	Enter the name of the payee or a description of the account.
EMPLOYEE SSN	Select the employee SSN from the list provided.  If this information is entered on Schedule 1 then this field is updated automatically.
EMPLOYEE NAME	Select the employee name from the list provided.    If this information is entered on Schedule 1 then this field is updated automatically.
AMOUNT	Enter the payment amount, as necessary.  Default = $0.00  If this information is entered on Schedule 1 then this field is updated automatically.
RESULTS	Enter one of the following codes: If this information is entered on Schedule 1 then this field is updated automatically.
	Result Code 1 = No suspicion of wages.
	Result Code 2 = Suspected but found NOT to be wages.  This includes all transactions that caused the Auditor to have any suspicion, required the Auditor to ask the employer about the payment, or caused the Auditor to look at supporting documentation.  Result Code 2 should be used and an explanation provided.  If the individual is an independent contractor, remember to list at least two common law factors supporting the decision that the payment is not wages. Reference: The section titled Additional Information About Schedule 3, (b) Potential Outcomes for addition information.
	Result Code 3 = Suspected and found TO BE additional wages for an employee.  The Auditor must indicate the services provided by the employee. Include explanation (two common-law factors) that supports the decision that the payment(s) listed was found to be wages. Examples of code 3 wages may include: bonuses, omitted payments, math errors, etc. Reference: The section titled Additional Information About Schedule 3, (b) Potential Outcomes for additional information.
	Result Code 4 = Wages previously reviewed. Used when the same payment is reviewed in more than one record, and a Result Code was previously entered for this payment. For example, an Auditor reviews the canceled checks and lists the payments on Sch. 3 as Code 7 wages (new employee discovered through the audit). There is also a Form 1099 for the same person, and it is listed on Sch. 3 also. If both listings for the payments were picked up as wages, the wage amount would be double what the employer actually paid the worker. One of the payments needs a result code of 7 (new employee discovered through the audit) and the second entry for the same payment would be coded as a 4 (wages previously reviewed), so that only one of the wage entries would be included in the audit summaries.
	Result Code 5 = Undetermined wages. Used when a decision about the entry has not been made. Initially the Auditor may not know if the payment was wages (such as a bonus) or not wages (such as a reimbursement of expenses). This code indicates that the entry on Sch. 3 regarding the payment has not been resolved. The Auditor cannot complete the audit until the issue is resolved.
	Result Code 6 = Vendor / Employee undetermined. This indicates that a decision about the employment status of the individual has not been made. The Auditor cannot complete the audit until the issue is resolved.
	Result Code 7 = Found to be wages for an unreported worker(s) added as the result of the audit.  This worker(s) may appear on previously or subsequently submitted quarterly reports for the time period included in the audit scope, even though the audit finds additional unreported (misclassified) wages.   The Auditor must indicate the services provided for the unreported wages.   Include in the explanation two common-law factors that support the decision that the payment(s) listed was found to be wages.  Reference: The section titled Additional Information About Schedule 3, (b) Potential Outcomes for additional information. Ex: Employee “A” is reported in the first quarter of the audit scope.   The employer changes the employee to a contract worker in later quarter(s), but the employee – employer relationship is unchanged.   Any unreported wages found for this worker will be added as code 7, with the required explanation.    Result Code 8 = Overreported Wages is used on the Edit Employee panel when removing wages exempt from reporting to TWC or other types of errors (i.e. math errors).  Comment should state the individual/services in question, and explain why in this individual’s wages are exempt or incorrectly reported. Examples: Spouse of owner, wages exempt under 201.065. Office staff, Employer incorrectly reported wages on wrong quarter due to data entry, see schedule 1.  No hidden wages or misclassified workers found. Office staff, Employer incorrectly reported wages when earned versus when paid, see schedule 1.  No hidden wages or misclassified workers found.
COMMENTS	Enter comments that clarify the results of reviewing the record. If this information is entered on Schedule 1 then this field is updated automatically. If the payment was for hidden or misclassified wages (code 3 or 7), indicate what the worker did to earn the money.  If the payment was to an independent contractor (code 2) explain what the worker did to earn the money.   In both cases the Auditor must list at least two common law factors that support the decision. Reference: The section titled Additional Information About Schedule 3, (b) Potential Outcomes for additional information.
TOTAL (ALL PAGES)	Displays totals for all Schedule 3 pages.
TOTAL WAGES (CODE 3 + Code 7)	Add all Result Code 3 wages (additional wages for acknowledged employees), and Result Code 7 wages (wages for misclassified workers discovered as a result of the audit), and enter the total.
OTHER COMMENTS	Comment on record types, discuss differences, or any other important item not listed in the body of this schedule. Remember that at least one record type in each category of records must be reviewed during the audit, and the results of that review must be identified on this schedule.
NO. OF MISCLASSIFIED WORKERS	Enter the number of new workers discovered as a result of the audit.
WAGES FOR MISCLASSIFIED WORKERS	Enter wages attributed to misclassified workers. The number entered here should only represent wages for the new employees discovered as a result of the audit. It should not include additional wages found for workers who were already acknowledged employees.

Chapter 7 of this manual contains information published by the Department of Labor for the Tax Performance System (formerly known as RQC - Revenue Quality Control). Several items and/or questions specifically relate to documenting the search for misclassified workers and hidden wages. For your convenience, four of those items are printed below.

• Item #5 of the Acceptance Sample Rationale of the TPS material.
  
  Other employer records must be examined to search for misclassified workers and hidden wages. (25 points)
  
  RATIONALE: Misclassified workers and hidden wages are the most significant areas of noncompliance among registered employers. Auditors must examine all appropriate documents or records of original entry as are available or maintained by employer to determine whether non-wage payments to acknowledged employees were properly classified and whether persons not in covered employment who received payments for services were properly classified. RQC has divided employer records into four types that will be examined for the discovery of hidden wages or misclassified workers. If no records or partial records are maintained by the employer, the Auditor must document that in the report. The audit is not to be penalized when the employer does not maintain all of the records described on the next page.
  
  The Auditor must examine the nature and extent of the employer's business to identify and resolve any issues of noncompliance. The nature of the business may identify a type of business with a historical pattern of noncompliance. In this case, the nature of the business may alert the Auditor to perform a detailed investigation of specific accounting records.
  
  Likewise, the extent of the business may indicate multi-state employment, and may require that the Auditor's investigation ensure the employer reported employees to the appropriate State.
  
  DOCUMENTATION: There are, at a minimum, four types of employer records that must be examined. Each should be considered as a separate source of potential information. Included in the completed audit file should be Auditor-prepared documentation that is the principal record of the four separate examinations for this test. The documentation must present the evidence discovered through the test.

• Question #13 of the Acceptance Sampling portion of the TPS material.
  
  Is it acceptable to review a sample of 1099's in lieu of reviewing all 1099's to meet the RQC requirements for examining records to search for misclassified workers?
  
  ANSWER: No. All 1099's must be reviewed to meet the RQC requirements in this section. Sampling of the 1099's would not identify all possible suspect payments thereby compromising the test in this area.
  
  The 1099's which have been categorized into separate types may be documented as groups in lieu of being individually detailed, provided the Auditor determines there is credibility in this method. Example: Auditor after categorizing the 1099's may document by stating 15 1099's were for dividends and 25 1099's were for interest.
  
  February 1994
  
  
• Question #20 of the Acceptance Sampling portion of the TPS material.
  
  In the Field Audit Rational Section: Misclassified workers - Why does the Field Auditor have to provide "evidence" that payments do not constitute wages?
  
  ANSWER: The information and data an Auditor obtains during the performance of an audit is the evidence that furnishes the reason and the support for the conclusion that payments do or do not constitute wages.
  

  For example: Bi-weekly payments are found in the cash disbursements journal classified as "other labor", to individuals not shown in payroll records. However, further inquiry reveals that these payments were for services not subject under provisions of law (e.g. payments to licensed contractors, in separately established businesses performing services for the employer under audit). Documentation could be: "Three individuals found in category of "other labor", not subject to provisions of law upon review of supporting documentation (e.g. vendor files, contracts), determined non employee services and not wages."

  Without this documentation there is no support for the Auditor's decision that the three individuals were not covered employees.
  
  May 1994
  
  
• Question #22 of the Acceptance Sampling portion of the TPS material.
  
  Does the Field Auditor have to compare employer's total wages to the UI contribution report and with the employer records on the SESA's automated system record?
  
  ANSWER: Yes. Field audit question "Does the audit contain documentation of the payroll record test--reconciliation of total payroll to total wages? The rationale states…"Work papers must show that the Auditor compared a payroll record (which was established as correct through verification of the payroll posting system) to the total wages on the employer's copy of the UI contribution report, and to the amount posted to the SESA's agency contains the actual information submitted by the employer on the employer's contribution report. The distinction is important to prove that information keyed into the employer's record accurately reflects information shown on the contribution report. The rationale for this question is to provide reasonable assurance that the employer payroll system is credible and reliable. There, both the employer's copy of the contribution report and the SESA's records must be reviewed either manually or by computer programs.
  
  Note: If the employer's copies of the contribution reports are not available and the audit documentation reflects this, the audit should not fail because the Auditor is unable to review the reports.
  
  May 1994