Avoiding IRS reclassification of workers as employees.

Executive Summary

The classification of workers as employees or independent contractors is a controversy significantly affecting many businesses. The primary defensive weapons available against an IRS challenge are the 20 factors provided by Rev. Rul. 87-41, and, in limited situations, Section 530 of the Revenue Act of 1978. However, as this article shows, in recent years, the courts have focused on just five of the ruling's factors and have provided some guidance on how to resolve the issue. As discussed in this article, this in-depth analysis should be helpful in avoiding IRS reclassification. The current legislative posture is also discussed.

The continuing controversy of whether workers should be classified as employees or independent contractors presents a serious dilemma for many businesses. This classification determines the applicability of payroll taxes, workers' compensation insurance, retirement plans and company fringe benefits. Worker status also is relevant for collective bargaining purposes and when assigning responsibility under civil rights acts. The past decade has been characterized by confusion, litigation and calls for simplification. Although legislation is pending, Congress has yet to provide relief

Without a clear standard, the IRS is aggressively pursuing additional taxes and penalties by reclassifying workers as employees; in fact, it has reclassified more than 400,000 independent contractors as employees since 1988 and currently reclassifies nearly 2,000 per week.(1) Further, the IRS has applied its own rules inconsistently, even in identical situations.(2) To quell the uncertainty faced by businesses, many alternative proposals have been presented.(3) Recently, the IRS announced two changes designed to achieve more uniform application of the standards: (1) National Office approval must be obtained for all local office reclassification projects and (2) additional training will be provided to examiners.(4)

An IRS reclassification includes not only assessments for the employer's share of payroll taxes but also interest and penalties, which can be substantial.(5) It also Can include the worker's share of FICA taxes, especially in flagrant situations or when they cannot be collected from the worker. If the hiring company is insolvent, the owners, officers and directors may be held responsible because the underpayment involves withholding taxes.(6) A worst-case scenario could result in the disallowance of the company's qualified pension plan because these "employees" (i.e., the independent contractors) were excluded from coverage.(7)

(1) Bovard, "The IRS vs. the Self-Employed," The Wall Street Journal, p. A14 (4/7/93). To improve its efficiency and consistency, the IRS has developed a computer expert system to determine classification status, SS-8 Determiner available for public use. (2) Approaches for Improving Independent Contractor Compliance (GAO/GGD-92-108, July 1992) (hereinafter, "GAO Study"). The Government Accounting Office (GAO) has frequently recommended that Congress enact clear and specific rules governing worker classification. (3) See Hulen, Kenny, et al., Independent Contractors: Compliance and Classification Issues (American Tax Policy Institute, Aug. 1993). (4) Tax Talk (IRS North Texas District, Fall 1995), p. 5. (5) GAO Study, note 2, estimates that $2.1 billion in payroll-related taxes are lost annually because approximately 3.4 million workers are misclassified as independent contractors. (6) See Roth and Biebl, "How to Avoid Getting Caught in the IRS Crackdown," 171 Journal of Accountancy 34 (May 1991), and Everett, Spindle and Turman, "Employee or Independent Contractor: A Determination with Far-Reaching Consequences," 9 Accounting Horizons 1 (Mar. 1995). (7) Workers reclassified as employees can also be assessed substantial additional taxes, even if they properly reported their incomes on Schedule C and paid self-employment taxes. Many deductions are lost on reclassification (e.g., business-related and travel expenses, home office deductions and contributions to pension and fringe benefit plans). FICA taxes plus income taxes on the lost deductions may exceed the refund due for any self-employment taxes paid.

Who is an Employee?

The controversy persists because there is no clear definition of "employee"; consequently, taxpayers have turned to the courts for help, but no definitive solution has resulted because the courts evaluate each case on its facts. The IRS issued Rev. Rul. 8741(8) to alleviate the conflict, but its 20 factors and the brief and general definitions may be misleading and confusing. The ruling's language is extremely subjective, and it states that the importance of each factor varies by individual, allowing the IRS considerable latitude to assert employee status.

This article provides a guide for classifying workers as either employees or independent contractors. (The discussion excludes domestic workers and workers designated as independent contractors under Sec. 3508 and Regs. Sec. 31.3401 (c)-1 (e). The protection afforded by the Revenue Act of 1978 (RA'78) Section 530 safe harbor is discussed first, followed by an explanation and evaluation of the Rev. Rul. 87-41 factors. Tax planning information is provided that should be helpful in avoiding or withstanding an IRS challenge.

Section 530 Safe Harbor

RA '78 Section 530 was enacted to prevent the IRS from arbitrarily reclassifying workers retroactively.(9) This safe harbor provides relief from payroll taxes if the hiring party consistendy treats workers as independent contractors and has a reasonable basis for doing so. A reasonable basis is determined by (1) judicial precedents, published rulings, or technical advice or letter rulings to the taxpayer; (2) a past IRS audit in which no assessment was made on similarly treated individuals, regardless of whether any IRS challenge was made; (3) long-standing recognized practice of a significant segment of the industry; or (4) some other manner, as discussed in Rev. Proc. 85-18.(10) Congress intended that reasonable basis be construed liberally in favor of the taxpayer. According to REAG, Inc.,(11) to prevail, "a taxpayer need only show a substantial rational basis for its decision to treat workers as independent contractors."

Frequently, Rev. Rul. 8741's 20-factor test is applied when "some other manner" is needed to prove reasonable basis. In such cases, the test is that the taxpayer was acting in good faith and had a reasonable basis for using independent contractor status. Consequently, Section 530 must be the first line of defense against IRS attempts to assess payroll taxes. Even if the IRS insists on use of the 20-factor test, the burden of proof is less onerous with Section 530.(12)

For Section 530 to apply, the hiring party must have treated all similar workers as independent contractors, and proper Federal tax documents (e.g., Forms 1099) must have been filed. If a business meets these conditions plus reasonable basis, it is protected from IRS retroactive reclassification, regardless of how common law defines the worker.(13)

Rev. Rul. 87-41

The courts have differentiated between employees and independent contractors by using common law rules. In Lowen Corp.,(14) the court recognized that neither the statutes establishing employment taxes nor the regulations are helpful in determining worker status. Thus, revenue rulings and case law must be examined.

The common law test generally used in the courts is stated in Regs. Sec. 31.3401 (c)-1 (b) and repeated in Rev. Rid. 8741:

[T]he relationship of employer and employee exists when the person or persons for whom the services are performed have the right to control and direct the individual who pcrforms the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished.

The regulation also provides thiat "it is not necessary that the employer actually direct or control the manner in which the services are performed," as long as "the employer has the right to do so." This right overrides all other evidence, including a contractual agreement stating that the worker is an independent contractor.

Most of the cases state that control is the dominant factor, although it is generally listed as only one of several factors the courts find important in determining a worker's status. Rev. Rul. 8741 states that it is an aid to be used to determine whether "sufficient control is present to establish an employer ... relationship."

The facts and circumstances of the situation must be considered in determining worker status. Rev. Rul. 8741 enumerates 20 factors that should be evaluated: 1. Instructions. 2. Training. 3. Integration. 4. Services rendered personally. 5. Hiring, supervising and paying assistants. 6. Continuing relationship. 7. Set hours of work. 8. Full time required. 9. Doing work on employer's premises. 10. Order or sequence set. 11. Oral or written reports. 12. Payment by hour, week, month. 13. Payment of business and/or traveling expenses. 14. Furnishing of tools and materials. 15. Significant investment. 16. Realization of profit or loss. 17. Working for more than one firm at a time. 18. Making service available to general public. 19. Right to discharge. 20. Right to terminate.

These factors, which are derived from prior cases and rulings, are to be used to help determine an individual's work status under common law rules. Recent court cases have generally focused on only a few of the 20 factors in determining a worker's status. To develop a reliable tax planning model, 20 tax cases decided after 1991 were identified and analyzed in this article.(15) Of these, 13 were decided by the Tax Court, six by district courts and one by the Ninth Circuit. A list of the cases examined appears in Table 1 at right.

Table 1: Cases Examined

Nicholas W. Adamson, N.D. Ill., 1994

Apollo Drywall Inc., W.D. Mich., 1993 (71 AFTR2d 93-1689)

Dan P Butts, TC Memo 1993-478

Harold E. Casety, Jr, TC Memo 1993-410

Crowd Management Services, Inc., 9th Cir., 1994 (74 AFTR2D 94-6372),
aff'g in part and rev'g in part 792 F Supp 87 (DC
Ore. 1992) (69 AFIR2D 92-1007,92-1 USTC [paragraph]50,170)

Juan P, deTorres, TC Memo 1993-161

Daniel M. Gierek, TC Memo 1993-642

Bobby, G. Hunter, TC Memo 1994-524

Peter H. Jacobs, TC Memo 1993-570

William O. Johnson, TC Memo 1993-530

John Laraway, TC Memo 1992-705

Donald J. Lewis Jr, TC Memo 1993-635

Lowen Corp., DC Kans., 1993 (72 AFTR2d 93-6350, 92-2
USTC [paragraph]50,360)

Audie D. Moore, W.D. Mich., 1992 (70 AFTR2d 92-5284, 92-2
USTC [paragrah]50,401)

Howard M. Potter TC Memo 1994-356

Robert A. Shelley, TC Memo 1994-432

A. Wayne Smithztick, TC Memo 1993-582
Martin L. Springfield, 873 F Supp 1403 (S.D. Cal. 1994) (75
AFTR2d 94-448)

Albert Ware, 850 F Supp 602 (W.D. Mich. 1994) (73 AFTR2d
94-1169, 94-1 USTC [paragraph]50,126)

Michael D. Weber, 103 TC 378 (1994)

Analysis

The 20-factor test must be applied to the entire working relationship. No one factor is decisive, not all of them are applicable in all situations, and they may be weighted differently across cases. Which factors are the most important? Although each situation differs, an identifiable pattern emerges from the 20 cases. Table 2 on p. 105 lists the top five predictive indicators in the cases examined. When this set of five factors is used to predict the courts' classification decisions in the 20 cases, it is accurate for 18 (90%) of the cases.

Table 2: Top Five Factors(1) Most Predictive
of Overall Classification

1. Instructions.

2. Furnishing of tools and materials.(2)

3. Significant investment.(2)

4. Payment by hour, week, month.

5. Realization of profit or loss.

(1) Of the 20 cases examined in this article.
(2) Tied for second place.

A significant point is that each of the five factors is tangible, measurable and relatively easily defined. Thus, businesses seeking to avoid conflict with the IRS should, at a minimum, concentrate on these five factors to ensure that they support the desired classification, and comply with as many of the remaining factors as possible.

Five Primary Factors

Factor #1: Instructions

Employers ordinarily have the right to specify the basic elements of the work and require that employees comply; in contrast, independent contractors generally do not receive instructions from the hiring party on how to perform their jobs. Businesses hiring independent contractors are usually interested only in the result and not in the methods of achieving it; consequently, the right to require workers to comply with how, when and where they are to perform their jobs suggests control by the hiring party, which favors employee status.

This factor was discussed in 19 of the 20 cases analyzed and the final determination of status was always in agreement with the classification under this factor.(16) Consequently, this factor is crucial to tax planning in this area. Generally, the courts held that individuals who were free to use their own methods and were not directed or supervised in their daily activities exhibited characteristics of independent contractors.(17)

In contrast, if the worker had a contract with specified guidelines or instructions, or a schedule or specific includes, he was deemed to be an employee.(18)

An employment relationship also may be deemed to exist if the hiring party either actually exercises control or simply has the right to. For example, in Johnson, the existence of a contract containing written policies and terms of performance proved the hiring party had the right to control, even though the worker, a seller of hospital equipment, received no actual instructions; thus, Johnson was an employee.

Factor #12: Payment by Hour, Week, Month

Independent contractors are generally paid by the job, on commission or by lump sum. Hiring parties that compensate their workers on a regular schedule (e.g., by the hour, week or month) are exhibiting control, indicating employee status. Of the 19 decisions considering this factor, seven held contrary to the final ruling.(19)

Generally, the courts stated that independent contractor status was indicated when workers were paid on a commission-only basis, even if such payments were made on a schedule(20); in contrast, systematic payments and hourly and daily wage rates tended to indicate employee status.(21) In Moore, which involved a trucker, weekly paychecks indicated employee status, even though workers were paid based on miles traveled and deliveries made.

Factor #14: Furnishing of Tools and Materials

Independent contractors generally own and provide the needed materials, tools, and supplies; however, if the hiring party provides these items, an employee relationship is indicated. This factor was mentioned in 18 cases, but resulted in a contrary status in five of them.(22)

If the worker provided a majority of the equipment or the most significant portion, independent contractor status was indicated.(23) If the worker provided only an insignificant monetary amount of tools, or the hiring party furnished the worker with all or the most necessary supplies and tools, employee status was indicated.(24)

Factor #15: Significant Investment

Workers who invest in facilities (e.g., an office) in which they perform all or part of the work are generally deemed to be independent contractors. A lack of investment, or an insignificant investment, is more typical of an employee.

In the 17 cases that discussed this factor, independent contractor status was indicated for workers who provided their own office space.(25) Lack of investment in the business or office facilities provided by the hiring party indicated employee status.(26) The holding conflicted with this factor in just four of the 17 cases.(27)

In Ware, the court determined that a majority of the investment (in office, ftirniture and equipment) was made by the worker, which favored independent contractor status. In Lowen Corp., there was no evidence of large investments by

Factor #16: Realization of Profit or Loss

Generally, an independent contractor risks realizing a profit or loss from his services. The courts linked the ability to earn a profit to the worker's skill or performance (e.g., management skills, production and efficiency).(28) However, some courts only look at the worker's opportunity for loss.(29) If a worker's risk of loss is due to liabilities or his personal abilities, independent contractor status is usually indicated; conversely, employee status is indicated when the worker has no opportunity for profit or loss. In Springfield, the court found that the worker could not realize a profit because there was no investment.

The opportunity for profit or loss as a determining factor was mentioned in 18 of the 20 cases, but only 15 courts used it in their analyses; the finding in 12 of those cases as to that factor was consistent with the final decision.(30)

Two Secondary Factors

Two additional factors appear to be almost as important as the five already discussed: set hours of work (#7) and working for more than one firm at a time (#17).

Factor 7: Set Hours of Work

Independent contractors usually determine when they will work on a particular job; in contrast, the ability to set an individual's hours is a form of control that usually indicates employee status. This factor was discussed in 15 cases and consistent with the outcome in 10.(31) Generally, the ability to set, determine or control one's own hours or have no set hours indicates independent contractor status.(32) if, however, the hiring party determined the worker's hours, employee status was more likely.(33)

Factor #17: Working for More Than One Firm at a Time

Performing services for different entities at the same time generally indicates independent contractor status; however, it is possible for an employee to have several employers similtaneously, according to Rev. Rul. 87-41. Two courts ruling that independent contractor status was indicated cited selling another company's products and having no restrictions on performing services for others.(34) In Moore, the fact that the workers "typically worked exclusively" for the hiring party supported employee status, even though workers could work for others. Individuals who were free to work for others but did not actually work for any other parties were deemed to be employees. Being prohibited from selling competing products was an indication of employee status.(35)

Three decisions were inconsistent with this factor. In Potter, although an individual worked for two separate businesses, he was deemed to be an employee. In Casety Jr, the worker's ability to work for others was unclear, but he was deemed an employee. Finally, in Ware, the worker was limited to selling the hiring party's products, but other factors favored independent contractor status.

The Remaining Factors

Although the remaining 13 factors were of much less importance than the factors previously discussed, they can be used to enhance an argument. When reasonably possible, businesses should ensure that activities involving these factors are favorable (or at least, not blatantly violative).

Factor #2: Training

Rev. Rul. 87-41 defines "training" an employee to include required attendance at meetings and instruction by an experienced worker or by correspondence; independent contractors generally are not required to participate in such training.

Required attendance at informational meetings complicates this factor. This factor did not enter into the ultimate classification decision when attendance at informational meetings was required, but no training was provided.36 Because of this uncertainty, this factor was consistent with the final decision in only four cases: when training was either clearly provided (Laraway), or clearly not provided (Apollo Drywall, Inc.), or the meetings were merely informational (Weber and Lewis, Jr). However, the court favored neither status on this factor in Moure, when a truck driver was trained to acquaint him with travel routes.

Factor #3: Integration

Rev. Rul. 87-41 provides that a worker who performs services important to the success or continuation of the hiring party's business is normally integral to the business and likely to be an employee. Being "part of the regular business," providing service in the ordinary course of business," or filling a key role in the business" favored employee status.(37)

Factor #4: Services Rendered Personally

A worker is generally an employee if required to personally perform the services, because the hiring party has control over the "methods" necessary to accomplish the results; independent contractors typically are not required to personally perform the services and may subcontract some or all of the work. In both Ware and Moore, the absence of a requirement to perform services personally and the ability to substitute workers indicated independent contractor status. In other cases, the worker could delegate duties (Shelley) or the contract was neither assignable nor transferable (Butts, Lowen Corp.).

Factor #5: Hiring, Supervising and Paying Assistants

Workers who can hire, supervise, pay and fire assistants are generally independent contractors. The inability to exercise this type of management function indicates that the hiring party has control, i.e., employee status. Typically, the unrestricted ability to hire, supervise and control staff or assistants indicates an independent contractor.(38) In Butts, Smithwick and Ware, the worker could hire with the hiring party's approval, and independent contractor status was favored.

Employees are generally barred from hiring assistants, or the business provides them.(39) The absence of assistants also may favor employee status; but, in Moore, the fact that the worker could hire assistants offset the fact that no assistants were hired, indicating neither status.

Factor #6: Continuing Relationship

Independent contractors' jobs are generally short-term, while a continuing relationship tends to indicate employee status. Rev. Rul. 87-41 notes that work "performed at frequently recurring irregular intervals may be considered a continuing relationship." The length of a continuing relationship was never clearly defined in any of the cases. Three years was the shortest period held to be continuing and indicated employee status in Moore. The only case that discussed a temporary relationship with the hiring party was Crowd Management, but the duration of the relationship was not mentioned.

Factor #8: Full Time Required

The full-time work factor is very similar to the "set hours of work" factor--if the worker is allowed to determine the number of hours worked, independent contractor status is generally indicated, but if the hiring party requires full-time work, this type of control indicates employee status. This factor seems simple to evaluate, but the courts examined some difficult situations. Employee status was favored when workers were substantially full time and the hiring party set the hours. In Ware, the individual was not required to work full time, but did, favoring neither status. In Moore, although full-time work was not required, it was needed to get the job done, indicating employee status. Not regulating, requiring or keeping track of hours indicated independent contractor status.(40)

Factor #9: Doing Work on Employer's Premises

Independent contractors usually have their own offices and places to perform their work. Performing the work at the hiring party's place of business, traveling a specified route and working in a certain place all tend to indicate employee status. Independent contractor status prevailed when workers performed activities at their own offices or otherwise away from the hiring party's premises.(41) Employee status was indicated when the hiring party required work to be done at an assigned place or on site or restricted at-home work.(42) This factor was found to be irrelevant in Moore, for a truck driver whose workplace was on the road, even though Rev. Rul. 87-41 indicates that employee status would be favored.

Factor #10: Order or Sequence Set

Rev. Rul. 8741 defines this factor as follows:

If a worker must perform services in the order or sequence set by the person or persons for whom the services are performed [the hiring party], that factor shows that the worker is not free to follow the worker's own pattern of work but must follow the established routines and schedules of the [hiring party]....

Workers were independent contractors if they were free to choose how they performed the work or did not follow established schedules, sequences or standards.(43) If the hiring party had enough control to dictate the sequence of the worker's job, employee status was favored.(44)

Factor #11: Oral or Written Reports

Independent contractors are rarely required to submit oral or written reports, but employees may be required to do so. Employee status was favored when any type of report was required to be submitted,(45) including a weekly trip report by a truck driver (Moore). One taxpayer (deTorres) successfully argued that the reports were common in his profession (project consulting engineering) and so were not a form of control by the hiring party.

Factor #13: Payment of Business and/or Traveling Expenses

An independent contractor generally has responsibility for and control over his own expenses. This factor favored independent contractor status when the worker paid a majority or all of the expenses.(46) If the hiring party paid expenses (e.g., for repairs and maintenance) or gave the worker a utility or travel expense allowance, employee status was favored.(47)

Factor #18: Making Services Available to General Public

Independent contractors regularly and consistently make their services available to the public. An absence of this factor may indicate an employment relationship. In Lowen Corp., the workers could make their services publicly available and some did. In other cases in which employee status was favored, hiring parties prohibited workers from offering services to the general public, or the workers agreed not to or did not offer their services.(48) Employee status was also found when the hiring party restricted and required consent for "undertaking outside functions" or the individuals worked entirely for the hiring parties with no evidence of making their services available to the public.(49)

Factor #19: Right to Discharge

Independent contractors usually cannot be fired if they accomplish the specified results; similarly, an employee cannot argue breach of contract for being fired. Rev. Rul. 87-41 explains that the ability to discharge gives a hiring party control. Being able to terminate the relationship at any time, at will, for convenience, with or without cause and with or without notice indicates a hiring party's right to discharge.(50)

The IRS argued in Butts that termination for unsatisfactory performance, when prior notice and an opportunity to correct the problem were given, was an attempt by the hiring party to exert control. The court found, however, that this was actually the hiring party's desire to manage the company's sales performance and not the worker's job; independent contractor status was thus held.

Factor #20: Right to Terminate

Independent contractors usually cannot terminate a working relationship without incurring a liability. Generally, the ability to terminate with or without cause and discontinue an association favored employee status.(51) In Moure, for example, there was no evidence that the worker's rights to terminate his employment were restricted, favoring employee status.

Other Studies

One study reviewed 40 (unspecified) court cases and concluded that there were nine primary factors under Rev. Rul. 87-41, including the five primary factors listed in Table 2.(52) Adding the four additional factors does not improve the ability to predict the final decision in the 20 cases examined herein.

Another study asked 93 CPAs who had advised clients about worker classification to complete a questionnaire on the 20 factors.(53) Five factors were identified as being most important: full time required; significant investment; realization of profit or loss (rated most important); working for more than one firm at a time; and making services available to the general public. The most significant finding is that those CPAs' five most important factors are in agreement with just two of the five primary factors identified from the 20 court decisions discussed herein and agree with just (the same) two factors from the nine-factor study. Thus, these practitioners' advice to clients may not prove to be successful if the client seeks relief in court from an IRS reclassification.

Because of the intensity of IRS reclassification audits, some practitioners are advising clients to seek a letter ruling for a determination (on Form SS-8, Determination of Employee Work Status). But this recommendation may be inadvisable unless the client prefers employee status or is ambivalent. One study(54) reviewed 346 private letter rulings and revealed that the IRS asserted that the workers were employees in 318 and independent contractors in 28. The rulings were often uninformative and unconvincing, the discussion of the factors was inconsistent, and frequently, few or none of the 20 factors were mentioned.

Conclusion

The reclassification of workers from independent contractors to employees places a high cost on businesses in the form of back taxes, interest and penalties, legal fees and higher future costs and paperwork. The worker also loses many Schedule C deductions; but an IRS objective, obtaining control over worker income reporting through a business, is achieved. Apparently, few traditional independent contractor professions are immune. For example, publishers are being notified that authors who receive royalties may be reclassified. This drive to reclassify workers as employees, however, may not be necessary, because the GAO found that workers report 97% of their Forms W-2 and 1099 amounts, but only 83% of their other earned income.(55)

The AICPA, GAO, American Tax Policy Institute and many other influential groups, as well as businesses and individuals, are lobbying Congress to establish fair, determinable and consistent safe harbor rules and guidelines. Proposed legislation in the form of the Independent Contractor Simplification Bill, H.R. 1972, would establish a three-part test to classify a worker as an independent contractor. Meanwhile, IRS auditors are routinely raising the classification issue even when Forms 1099 have been properly filed and die workers have reported the income correctly.

One traditional avenue open to taxpayers with controversial issues--letter rulings--seems to be all but closed to those who prefer independent contractor status; more than 90% of the rulings have held the workers to be employees. Thus, businesses with independent contractors must consider themselves at risk and should prepare now for a potential audit. Steps that should be taken in anticipation are:

[] Review Section 530 requirements carefully to determine possible applicability.

[] Obtain Form SS-8. Respond to the questions, carefully documenting all "no" answers. Focus on the "Yes" answers to determine if changes can be made.

[] Obtain information from independent contractors releant to the 20 factors listed in Rev. Rul. 8741. Documentation that could help avoid reclassification should be obtained and kept in files, including business cards, advertisements and telephone directory listings.

[] If the business or workers are part of a trade group or organization, contact these organizations to determine if they have useful information and experience. [] Consider a written contract with all independent contractors that contains the rights of both parties (focusing on the 20 factors and the tax responsibilities of each party) and a clause that in the event of an IRS reclassificafion, the independent contractor will reimburse the business for all payroll taxes (because the contractor is eligible for a refund of self-employment taxes).

[] Ensure that all Forms 1099 are properly filed for workers who are paid $600 or more during the year.

[] If it is determined that the business has a reasonable basis to classify some workers as independent contractors but not others, consider converting the latter group to employee status. This good-faith effort could help protect the independent contractor classification of the other group. Avoid inconsistent treatment among similar workers.

[] Ensure that all documents and references to the independent contractors are appropriate and that none can be construed as references to employees.

If an IRS audit or "compliance check" is conducted, evidence from the 20 court cases discussed in this article should be helpful in combating a reclassification. Ensure that the IRS is aware of the potential for litigation if no relief is found at the agent or IRS appeal level. The IRS does not appear to be interested in pursuing well-documented cases in court. (8) Rev. Rul. 8741, 1987-1 CB 296. (9) Although RA '78 Section 530 provides a valuable planning and protection tool, it is not in the Code. See H. Rep. No. 95-1748, 95th Cong., 2d Sess. 3 (1978), 1978-3 (Vol. 1) CB 629. (10) Rev. Proc. 85-18, 1985-1 CB 518. See IRM 4646, Determination of Employer-Employee Relationship, which contains a series of questions and a flowchart. (11) REAG, Inc., 801 F Supp 494 (DC Okla. 1992) (71 AFTR2d 93-1524,92-2 USTC [paragraph]50,475). (12) See Frank and Cooper, "How to Protect Clients Against IRS Attack on Independent Contractors," 174 Journal of Accountancy 63 (Dec. 1992), citing Critical Care Register Nursing, Inc., 776 F Supp 1025 (E.D. Pa. 1991) (68 AFTR2d 91-5716, 91-2 USTC [paragraph]50,481), nonacq., IRB 1994-32, 4, which held that the Section 530 safe harbor rules should be considered first. (13) Section 1706 of the Tax Reform Act of 1986 amended RA '78 Section 530(d) to provide an exception for technical service workers effective after 1986. Both the GAO and the IRS have recommended that the amendment be repealed. (14) Lowen Corp. determined the status of sellers of signs and decals. Citations for the 20 cases examined in this article are contained in Table 1 on p. 104. (15) Decisions based on Section 530 were eliminated because none of the 20 factors are relevant in those cases. (16) Only Jacobs does not discuss the relevance of instructions. The taxk3Npa),er a management consultant. (17) See, e.g., deTorres (civil engineer); Shelly (minister); Hunter (advertising seller); and Apollo Drywall, Inc. (drywaller). (18) See, e.g., Weber (minister); Laraway (auto mechanic); Casety, Jr (paralegal); and Moore (trucker). (19) See, e.g., deTorres, Johnson (hospital equipment seller); Lewis Jr (hair care products seller); Gierek (stockbroker); Shelley; Hunter; and Splingfleld (auto seller). (20) See, e.g., Butts (insurance seller); Johnson; Smithwick (insurance seller); Lewis, Jr; Gierek; Lowen Corp.; Ware (insurance seller); and Springfield. (21) See, e.g., Weber; Laraway; detarres; Potter (college teacher); Shelley; Hunter; Adamson (plumber); and Crowd Management Services, Inc. (security personnel). (22) See deTorres; Johnson; Lewis, Jr.; Shell?; and Lowen Corp. (23) See, e.g., Butts; Smithwick; Apollo Drywall, Inc.; and Ware. (24) See Weber; Laraway; Casety, Jr.; Gierek; Moore; Lowen Corp.; Adantson; Spnnglield; and Crowd Management Services, Inc. (25) See, e.g., Butts; Smithzvick; and Ware. (26) See, e.g., Weber; Laraway; Casety, Jr; Jacobs; Gierek; Potter; Shelley; Moore; and Springfield. (27) See deTorres; Johnson; Lewis, Jr.; and Sheilley. the workers, but the court thought that any investment made by the workers suggested independent contractor status. (28) See, e.g., Lowen Coip.; Ware; and Adamson. (29) See, e.g., Smithwick, Lewis Jr.; and Gierek. (30) See Weber; Laraway; Butts; Smithwick; Lewis, Jr; Potter; Hunter; Moore; Ware; Adamson; Springfield; and Crowd Management Services, Inc. (31) See Laraway; deTorres; Butts; Potter; Shelley; Hunter; Moore; Apollo Drywall, Inc.; Lowen Corp.; and Adamson. (32) See deTorres; Butts; Johnson; Lewis, Jr.; Gierek; Shelley; Hunter; and Lowen Corp. (33) See, e.g., Laraway; Potter; and Adamson. If the hiring party controls assignments, this can be construed as control of hours worked; see Moore, but see Ware, in which the hiring party set office hours, but did not require the worker to be there, indicating neither status. (34) See Butts and Shelky. (35) See Lewis Jr and Lowen Corp. (36) See, e.g., Butts; Johnson; Smithwick; Gierek; Shelley; Lowen Corp. ; and Ware. (37) See, e.g., Weber; Jacobs; Lewis, Jr.; and Potter. (38) See Shelley; Apollo Drywall, Inc.; and Lowen Corp. (39) See Weber; Johnson; and Gierek. (40) See Hunter; Apolto Drywall, Inc.; and Lowen Corp. (41) See deTorres; Butts; Smithwick; Lowen Corp.; and Ware. (42) See Weber; Gierek; and Springfield. (43) See, e.g., deTorres; Lowen Corp.; and Ware. (44) See, e.g., Weber; Moore; and Potter; see also the discussion under "Factor #1: Instructions." (45) See, e.g., Weber and Lewis Jr. (46) See, e.g., Butts; Smithwick; Hunter; and Ware. (47) See, e.g., Webffand Moore. (48) See, e.g., Weber; Johnson; and Jacobs. (49) See Laraway; Gierek; and Moore. (50) See, e.g., deTorres; Butts; Johnson; Smithwick; Gierek; Potter; Lowen Corp.; and Ware. (51) See, e.g., Butts; Johnson; Smithwick; and Gierek. (52) See Sumutka, "Employee or Independent Contractor?," 62 The CPA journal 48 (Apr. 1992), which listed the following nine factors: instructions; hiring, supervising and paying assistants; set hours of work; order or sequence set; payment by hour, week, month; furnishing of tools and materials; significant investment; realization of profit or loss; and right to discharge. (53) Apostolou, Beehler and Hassell, "The 20-Factor Worker Status Test: Would Seven Factors Work Just as Well?," Tax Notes Today (12/13/93), p. 17. (54) See Frank, "Independent Contractor vs. Employees: Guidelines for the Practitioner," 22 The Practical Accountant 16 (Dec. 1989). A review of more recent letter rulings indicates that there is no significant change from the study. (55) See Tax Administration: Missing Independent Contractors' Infarmation Returns Not Always Detected (GOA/GGD-89-110, 1989).