Classification settlement program.

On Mar. 5, 1996, the Service announced a two-year test of a Classification Settlement Program, designed to resolve worker classification cases as early in the administrative process as possible, as well as to ensure that relief under Section 530 of the Revenue Act of 1978 is properly applied. IRS examiners will be permitted to negotiate a settlement based on the strength of the taxpayer's Section 530 case.

The Classification Settlement Program is based on Section 530, which can grant relief from a reclassification of an independent contractor as an employee, if the taxpayer meets a three-factor test:

1. Reporting consistency: All Federal tax returns required to be filed by the taxpayer with respect to the individual must have been filed on a basis consistent with the worker's classification.

2. Substantive consistency: The taxpayer must have consistently classified similarly situated workers.

3. Reasonable oasis: The taxpayer must have had a reasonable basis for the worker's classification.

If the Service determines that a worker has been misclassified as an independent contractor, the examiner must determine whether Section 530 relief would apply. If Section 530 relief applies, despite the fact that workers have been misclassified, the employer is not subject to assessment of any employment taxes that would result from reclassification, and the workers need not be reclassified prospectively. If Section 530 relief does not apply, the examiner and group manager will determine whether the taxpayer is eligible for a settlement offer.

To qualify for the Classification Settlement Program, the taxpayer must meet the "reporting consistency" requirement. If the, taxpayer "clearly cannot meet" either of the other factors of the test, the settlement will be for prospective treatment plus a full employment tax assessment of one tax year computed using Sec. 3509, if applicable. If the taxpayer has a "colorable argument" that it meets the substantive consistency test and the reasonable basis test, settlement will be for prospective treatment plus one quarter of an employment tax assessment for one tax year. When the IRS is examining the classification of several classes of workers, each class of worker may be subject to a different settlement. If the taxpayer is eligible for a settlement under the program, the Service will offer it a nationally standardized closing agreement.

Participation in the Classification Settlement Program is voluntary and is available for two years beginning with any open cases in Examination or Appeals on Mar. 5, 1996. The program in no way affects a taxpayer's administrative appeal rights.

Through the Classification Settlement Program, taxpayers may have the opportunity to resolve a dispute as to worker classification expeditiously and at a lower cost than with the Examination and Appeals processes. However, taxpayers must evaluate whether they may have a better opportunity for settlement at Appeals than would otherwise be available at Examination. For example, if the taxpayer has a strong Section 530 relief argument, Appeals may be willing to settle for prospective reclassification only (an alternative not available through the Classification Settlement Program). The greater latitude afforded Appeals is due, in part, to the discretion Appeals has in examining factors (such as the hazards of litigation) that Examination generally may not consider. However, the IRS has indicated that once a settlement offer is declined, if the taxpayer subsequently raises the issue with Appeals, the settlement offer from Examination is no longer a consideration and cannot be resurrected.

FROM JOANNE FAY, J.D., WASHINGTON, D.C.