New IRS procedures for worker classification disputes.

Recently enacted Sec. 7436 authorizes review of IRS worker classification determinations by the Tax Court, effective for determinations made after Aug. 5, 1997. In Notice 98-43, the Service has described the issues subject to review, the parties eligible to seek review and the formal prerequisites for review.

Background

Many employment tax disputes center on whether a particular worker is an independent contractor or a common-law employee of the service recipient. Typically, the relevant inquiry is fact-intensive, focusing on a spectrum of factors relating to the kind and degree of control exercised by the service recipient over the worker.

Another common employment tax issue is whether the service recipient (even if technically a common-law employer) qualifies for relief under Section 530 of the Revenue Act of 1978. That law, in general terms, prohibits the IRS from reclassifying a worker as an employee for employment tax purposes if the service recipient satisfies several criteria, such as treating workers occupying similar positions of responsibility in a similar fashion for tax purposes and having a reasonable basis for the tax treatment of the worker in question.

Traditionally, refund litigation in Federal district court or the Court of Claims (and its successors) was the sole means of challenging an IRS worker reclassification or a denial of Section 530 relief. Sec. 7436, however, now vests the Tax Court with prepayment jurisdiction over such challenges. It also permits taxpayers to elect small-case procedures, similar to those that apply in income tax cases; these procedures apply when the amount of employment tax in dispute is $50,000 or less for each calendar quarter involved.

Notice 98-43

Issues. The Tax Court's jurisdiction under Sec. 7436 is strictly limited; the Tax Court may not decide the amount of any employment tax liability or penalties. It may not decide employment-related issues not arising under the employment tax laws (e.g., the classification of individuals as employees for qualified plan purposes). It may decide only worker classification and Section 530 issues resulting from an examination. Thus, for example, worker classification determinations made as part of the letter ruling process are not subject to Tax Court review.

Parties. Neither a worker nor a third party that has not been determined by the Service to be an employer may seek review under Sec. 7436.

Prerequisites to review. Sec. 7436(a) requires a "determination" by the IRS as to worker status or the applicability of Section 530 relief. Notice 98-43 describes new procedures relating to the determination process.

As in the past, the Service will send the taxpayer a 30-day letter in an unagreed employment tax case. The 30-day letter permits the filing of a protest with the IRS Appeals Division from the examiner's findings. If. the taxpayer does not respond to the 30-day letter or elects to forgo an administrative appeal, the Examination Division will send the taxpayer a Notice of Determination (NOD) by certified or registered mail. (A model Notice of Determination is attached to Notice 98-43.) If the taxpayer pursues an administrative appeal and the case remains unsettled at the conclusion of the appeals process, the Appeals Division will issue the NOD.

The NOD will schedule the kinds of taxes asserted to be due and the proposed adjustments by calendar quarter. The Service's figures are intended to enable the taxpayer to determine whether it is eligible to elect the small case Tax Court procedures.

If the taxpayer wishes to pursue Tax Court review, it must file a petition with the court before the 91st day after the issuance of the NOD.

The issuance of an NOD generally will suspend the statute of limitations on assessment during the 90-day petition period. If a petition is filed, the suspension will remain in effect until the decision of the Tax Court becomes final, plus 60 days thereafter. Assessment and collection are stayed during the suspension period.

Notice 98-43 provides that the NOD embodies the "determination" required under Sec. 7436. Tax Court review prior to the issuance of the NOD is not available. Worker classification cases docketed in Tax Court will be referred to the IRS Appeals Division under Rev. Proc. 87-24, unless Appeals issued the NOD.

Observations. Notice 98-43 provides several useful insights. To begin with, it is apparent that the Service will attempt to keep Sec. 7436 proceedings tightly focused and will resist, on jurisdictional grounds, taxpayer efforts to directly or indirectly present or address nonemployment tax, worker-related issues. (Because the common-law formulation of employment status cuts widely across the Code, a Tax Court determination of worker status under Sec. 7436 may still, as a practical matter, have many collateral implications.)

In addition, it is clear that, in establishing the NOD as the ticket to the Tax Court in Sec. 7436 cases, the IRS has narrowly defined the statute's "determination" concept. A statutory notice of refund claim disallowance does not embody the requisite determination. Presumably, as with a deficiency notice relating to income, estate and gift taxes, the Service intends to limit the issuance of an NOD to prepayment situations.

Moreover, the IRS has cleared up whether, under Sec. 7436, a taxpayer will be allowed to go to Tax Court twice--once regarding the applicability of Section 530 relief and a second time to dispute worker status under common-law rules. The Service apparently intends to address both Section 530 and worker-status concerns during the administrative phases of a dispute, prior to the issuance of an NOD. This would seemingly block two trips to the Tax Court.

The IRS also has clarified that, in docketed Sec. 7436 cases, the provisions of Rev. Proc. 87-24 apply (as they do in income, estate and gift tax cases). Thus, taxpayers who have not had (or who have forgone) the opportunity for administrative appeal prior to the issuance of an NOD will be afforded that opportunity.

Still, Notice 98-43 leaves many questions unresolved. For example, do last-known address rules, similar to those applicable to a deficiency notice (Sec. 6212(b)), apply to an NOD? Once an NOD is issued, does the taxpayer lose the benefit of Sec. 6205, which allows a taxpayer to administratively resolve an employment tax controversy without paying underpayment interest in some circumstances? (See Rev. Proc. 75-464.) In a related vein, will the Appeals Division or the Service's lawyers refuse to bargain in Sec. 7436 cases over non-Section 530 or worker status issues (e.g., the applicability of a reduced rate of tax under Sec. 3509)? In addition, if the taxpayer elects to forgo Tax Court in favor of refund litigation in a worker classification dispute, what collection posture will the IRS take? In the employment tax (unlike the income tax) setting, the taxpayer can bring suit after paying a portion of the total tax in dispute; the Service has traditionally forgone enforced collection action on the assessed balance (except when collection was jeopardized), pending the outcome of the refund suit. Will this policy continue, now that Sec. 7436 offers taxpayers a prepayment forum? Future guidance on such matters can be expected.

FROM RONALD A. STEIN, LL.M., CPA, CHICAGO, IL