Independent contractor safe harbor proposal.

Introduction

The American Institute of Certified Public Accountants (AICPA) appreciates this opportunity to testify on the issue of classification between independent contractor and employee. We commend your timeliness in holding this hearing on an issue which was designated by delegates attending the White House Conference on Small Business as the one most in need of Congressional attention. The AICPA is the national professional organization of CPAs, with over 320,000 members. Many of our members are tax practitioners who work with millions of American taxpayers--individual and business. We appreciate this opportunity to express our commitment and support for the concept of voluntary compliance. By reducing complexity through clarification of definitions to prevent misclassifications of independent contractors, we believe that greater compliance will be achieved.

We have, for several years, supported legislation that would (1) offer a safe harbor for business people to provide certainty in business decision making, (2) modify the prior audit rule of Section 530 of the Revenue Act of 1978, which protects taxpayers against retroactive reclassification of workers as employees, (3) give the Secretary of the Treasury the authority to define the term "employee" by regulation, and (4) achieve conformity in the definition of employee for income tax, employment tax and health care purposes.

In addition, we are deeply concerned with the amount of unreported income resulting in part from failure to file Forms 1099, as well as attempts by the IRS to classify independent contractors as employees. Accordingly, we support a provision to increase penalties for failure to file correct information returns with respect to nonemployees.

Section 530 of the Revenue Act of 1978 currently provides safe harbors which allow workers to be deemed independent contractors in certain situations. However, these safe harbors are available to very few businesses and, even if available, do not solve other problems such as fringe benefit issues. Current initiatives by the IRS which designate critical factors for determining independent contractor status for specified industries are not sufficient to safeguard small business and in fact may complicate their compliance efforts. Small business is an industry by itself and it needs a comprehensive all-encompassing safe harbor regardless of industry. The AICPA therefore supports the adoption of a simple safe harbor, which, if the provisions are met, would guarantee independent contractor treatment of a worker. The safe harbor would also increase revenue and compliance as more businesses realize the benefit of certitude in their transaction.

The AICPA Tax Executive Committee, Private Companies Practice Executive Committee, Management of an Accounting Practice Committee and Small Firm Advocacy Committee have all approved our new safe harbor. The American Institute of Certified Public Accountants is concerned that the independent contractor issue has dominated Internal Revenue examinations of small businesses in recent years. In many cases, the small business owner has made a good faith attempt to classify a worker under the current common law tests as an independent contractor only to be challenged upon examination by the Internal Revenue Service. This challenge has resulted in large tax, penalty and interest assessments for misclassification of workers, even when appropriate information returns have been filed and the workers have reported the income and paid their tax. These examinations result in undue hardship on the small business because of the accounting and legal fees incurred, time spent in defending their positions and no certainty in the treatment of the worker at the time of payment. This issue must be resolved.

The AICPA recommended safe harbor, which is outlined below, is not intended to change any of the other current means of determining independent contractor status, such as the common law tests. The safe harbor is proposed as a means to resolve issues of misclassification, unreported income and tax collection for payments made to workers in the ordinary course of business. The safe harbor would not cover domestic workers. It should be noted that the committee believes that safeguards have been built into the proposal to discourage employers from relying on the safe harbor to turn employees into independent contractors. The AICPA believes that other issues, such as liability issues, business reasons to develop long term employee relationships, worker compensation and marketplace factors will be taken into account and will continue to result in employers treating most workers as employees.

Proposed independent contractor safe harbor

A safe harbor test would be codified which would provide that an individual performing nondomestic services for a business would be treated as an independent contractor by the business and that status would be respected by the IRS for all purposes of the Code, if the following requirements are met:

1. The business and the individual worker would execute a written agreement prior to the performance of services. The agreement would include the following:

a. A description of the services to be provided and the duration of the agreement.

b. The remuneration to be paid by the business to the worker.

c. Agreement that the individual worker is responsible for his or her own federal and state income taxes, including self-employment taxes, and any other taxes.

d. Agreement that the business will not provide the worker with fringe benefits.

e. Acknowledgment by the individual worker that he or she has complied with applicable business licensing requirements and that appropriate books and records are maintained.

f. Acknowledgment by the parties that their relationship is that of an independent contractor.

2. The business would withhold a minimum of 5% from all payments for services to the individual worker as federal income tax withholding and remit it to the IRS monthly. The worker would receive credit for this safe harbor withholding when he or she filed an annual income tax return.

3. The safe harbor would not be available to a business or controlled group with respect to a worker who had in the past twelve months performed services as an employee of that business similar to those covered by the agreement.

4. The business files appropriate Forms 1099 with Internal Revenue Service and the worker.

The AICPA believes that many of the workers who would be covered by this safe harbor are currently being treated as independent contractors. Therefore, revenue may be enhanced rather than reduced because of the 5% mandatory safe harbor withholding. Additionally, the requirement of a written agreement between the parties prior to the performance of services eliminates the confusion that sometimes exists under the current system.

Millions of dollars are spent annually by the IRS and the American business community in worker classification disputes. The AICPA believes that the proposed safe harbor would eliminate those wasted efforts. This safe harbor would allow the IRS to free up wasted resources which could be used to increase compliance by educating taxpayers and searching for other types of unreported income.