The Service is concerned about widespread noncompliance with the employment tax rules, and has a number of specific targets on its audit list, including:

- S corporations. Since salaries are subject to payroll taxes, and S corporation dividends are not, a number of taxpayers appear to be structuring businesses as S corporations to deliberately take low salaries and pay out the remainder of profits as S corporation dividends. The IRS views this as inappropriate tax avoidance when the salary doesn't reasonably reflect the economic reality of the owner/employee's work for the company. Where the owner/employee's salary is unreasonably low relative to his or her services rendered, the IRS has the power under the tax code to re-allocate income so it better reflects economic reality (and collect the appropriate payroll taxes, plus interest and penalties as appropriate).

- Nonfilers. The IRS wants to reduce the number of taxpayers that fail to file any employment returns at all. In particular, it's after small businesses that may be withholding payroll taxes from employee paychecks, but are not actually filing employment returns and remitting the collected taxes to the government.

- Fringe benefits. The IRS is particularly concerned about cash payments to employees that are labeled as non-taxable health plan reimbursements, but are not really eligible for tax-exempt status under prescribed rules.

In light of intensified IRS scrutiny, advisers should be on their guard about tax planning strategies for small business clients who want to reduce or avoid payroll taxes. Strategies that flout current regulations, do not follow IRS requirements, or fail to reflect economic realities, may very well be discovered under the increased audit focus.