Taxes and public entity employees: the scope of section 530 of the Revenue Act of 1978.

Public entities, particularly government-owned hospitals, are concerned about an obscure corner of the internal revenue law, with lots of money at stake. In certain circumstances, section 530 of the Revenue Act of 1978(1*) provides relief from worker classification controversies regarding "employment taxes" imposed under subtitle C of the Internal Revenue Code. In Technical Advice Memorandum (TAM) 9151004,(2) the IRS ruled that section 530 relief is not available to public employers. This position denies to the public employer the safe haven from employment tax controversies allowed to the private sector and forces the public employer into the cauldron of "common law factors"(3) to distinguish employees from independent contractors.

The IRS's interpretation of section 530 is based on the agency's analysis of legislative intent. It is an interesting example of administrative law-making in the face of unambiguous statutory language. This article examines the language, legislative history, and policy underlying section 530 of the 1978 Act in the context of the imposition of employment tax liability on state and local government. It concludes that both the initial premise and the logic of TAM 9151004 are faulty.

Section 530 In General

Section 530(a)(1) of the 1978 Act provides in part that if -

(A) for purposes of employment taxes, the taxpayer

did not treat an individual as an employee

for any period, and

(B) in the case of periods after December 31,

1978, all Federal tax returns (including information

returns) required to be filed by the

taxpayer with respect to such individual for

such period are filed on a basis consistent

with the taxpayer's treatment of such individual

as not being an employee,

then, for purposes of applying such taxes for such period with respect to the taxpayer, the individual shall be deemed not to be an employee unless the taxpayer had no reasonable basis for not treating such individual as an employee.

Section 530(c)(1) defines "employment taxes" to which the provision applies as "any tax imposed by subtitle C of the Internal Revenue Code of 1954."(4)

The distinction between employee and independent contractor is significant, particularly for the employer. Employee status for a worker requires the employer to withhold income tax payments from the employee's wages,(5) requires employer payment of both the employer and employee portions of the Social Security tax (imposed under the Federal Insurance Contributions Act (FICA)),(6) and, with respect to private employers, employer and employee contributions under the Federal Unemployment Tax Act (FUTA).(7) For the worker, independent contractor status means that he or she must pay self-employment taxes with his or her individual return.(8) Many workers claiming independent contractor status will also claim they are engaged in a trade or business as an independent contractor for income tax purposes. Section 530, however, clearly provides that its safe-harbor relief is available only with respect to employment taxes under subtitle C of the Code.(9)

Section 530 was enacted in response to a period of increased enforcement of employment tax laws by the IRS that created disputes over the classification of workers as independent contractors or employees.(10) An IRS victory in a reclassification case often required the taxpayer to pay employment tax deficiencies that reflected self-employment and income taxes already paid by the employee.(11) In effect, therefore, the tax was collected twice. Although income tax payments by the reclassified worker were available to the employer as an offset against the employer's income tax withholding liability,(12) and the IRS had allowed offsets for employment taxes paid by the worker if the employer was able to provide worker's name and Social Security numbers, the information necessary to claim abatement was not always available to the employer.(13) Congress thus decided in 1978 to "provide interim relief for taxpayers who are involved in employment tax status controversies with the Internal Revenue Service, and who potentially face[d] large assessments, as a result of the Service's proposed reclassifications of workers ...."(14)

Section 530 was initially intended to provide only temporary relief for classification controversies while Congress developed a comprehensive solution.(15) To date, however, Congress has failed to find that solution. Section 530 remains in effect, essentially as enacted in 1978.(16)

Technical Advice Memorandum 9151004

Technical Advice Memorandum 9151004 concludes that Congress could not have intended to apply section 530 to public entities because, at the time section 530 was enacted, the FICA and FUTA taxes were not technically imposed on public employers. Subsequent imposition of FICA liability on governmental employers was limited to defined circumstances.(17) Governmental employers remain exempt from FUTA.(18) Since the enactment of section 530, however, public employers have been subject to income tax wage withholding.(19) The technical advice memorandum states:

The history of the treatment of workers for federal

employment tax purposes, which clearly indicates

that state and local government employers and

employees are accorded different treatment than

private employers and employees, leads to the inescapable

conclusion that Congress never intended to

provide section 530 relief to public employers.

Application of Section 530 Under

the Current Statutory Scheme

The first and most significant difficulty with the IRS position in TAM 9151004 is the unambiguous language of section 530: the statute explicitly states that it is applicable to any employer subject to taxes under subtitle C of the Code.(20) Public entities are taxpayers subject to subtitle C employment taxes.

Chapter 21 of subtitle C of the Code (FICA) imposes two separate taxes on an employer based on the wages of an employee. FICA imposes a tax on an employer based on the income of employees measured as a percentage of wages "received by [the employee] with respect to employment."(21) The tax is collected by the employer and deposited with the IRS.(22) Section 3111 of the Code imposes an additional FICA tax on employers as an excise tax "with respect to having individuals in his employ, equal to [a percentage] of wages. . . paid by him with respect to employment . . ." Before 1987, "employment" was defined for FICA purposes to exclude (with certain exceptions not relevant to this article(23)) service performed in the employ of a State or a political subdivision. Nevertheless, many public entities made FICA contributions on behalf of employees, not as "taxes" under subtitle C, but pursuant to an agreement under section 218 of the Social Security Act.(24) The section 218 agreement permitted a state or local government to voluntarily bring employees not otherwise covered by a retirement system into the Social Security insurance system.(25) The Budget Reconciliation Act of 1986 added section 3121(b)(7)(E) to the Code providing that "employment" for FICA purposes includes "service included under an agreement entered into pursuant to section 218 of the Social Security Act."(26) Thus, under section 3121(b)(7)(E) of the Code, wages paid by an employer subject to a section 218 agreement became wages from employment subject to FICA tax under subtitle C. The Omnibus Budget Reconciliation Act of 1990 broadened the reach of the FICA tax with the addition to the Code of section 3121(b)(7)(F), which expands the definition of employment to include service as an employee for a state or local government entity unless the employee is a "member of a retirement system" of such entity.(27) Under these provisions, many state and local governmental entities became taxpayers subject to the subtitle C taxes imposed by sections 3101 and 3111 of the Code. The literal language of section 530 of the 1978 Act, which extends the relief provided to qualifying "taxpayers" of employment taxes imposed by subtitle C of the Code,(28) thus appears to apply to a governmental entity subject to FICA tax.

TAM 9151004 takes the position that under these provisions state and local governments have been treated differently from private employers, and the differences justify disparate treatment under section 530. The technical advice memorandum states that the different treatment is proper because (i) under the 1987 Act there was no FICA liability unless the State had agreed to provide coverage for designated employees under a section 218 agreement, and (2) under the 1990 Act there is no liability for FICA if the services are not included in a section 218 agreement and the employee is a member of a retirement system. Thus, TAM 9151004 asserts that Congress never intended to provide section 530 relief to public employers.(29) The differences cited in the technical advice memorandum, however, do not change the statutory language of section 530. The statute applies to taxpayers subject to subtitle C taxes, a group that includes public employers by virtue of sections 3121(b)(7)(E) and (F).

The legislative history of the 1978 Act draws no distinction between public and private employers - there is nothing to suggest that section 530 is not applicable to public entities.(30) As previously stated, the House Report explains Congress's reasons for enacting section 530 by pointing to difficulties faced by "taxpayers" as a result of the IRS's employment tax audits.(31) Paramount among these problems was the fact that taxpayers were sometimes assessed for employment tax liabilities already paid by employees that, because of lack of information, could not be claimed by the employer as an offset to its own tax liability.(32) The House report on the 1978 Act explains:

The bill provides an interim solution for controversies

between the Internal Revenue Service and taxpayers

involving whether certain individuals are

employees under interpretations of the common law. . . .

The bill provides relief from employment tax liability

to certain taxpayers involved in employment tax

status controversies with the Internal Revenue Service

as a result of the Service's proposed reclassification

of workers, whom taxpayers have considered

as having independent contractor status or

some other status (e.g., customer), as employees.(33)

A public entity under audit by the IRS is a taxpayer involved in an employment tax status controversy with the IRS as a result of the IRS's proposed reclassification of workers. A public entity faces the same problem as a private employer with large back taxes and its inability to secure information regarding the returns of workers who may have paid income and self-employment taxes as independent contractors.

The legislative history of the extensions and amendments of section 530 underscores this analysis. Basically the committee reports repeat the description of section 530 that Congress first developed in 1978.(34) In 1979, for example, the Senate Finance Committee stated:

The Revenue Act of 1978 provided interim relief ...

for certain taxpayers involved in controversies with

the Internal Revenue Service over IRS-proposed re-classification

of workers, whom the taxpayers had

considered independent contractors, as employees.

In general the Act terminated taxpayers' potential

liabilities for Federal income tax withholding, social

security and FUTA taxes in cases where taxpayers

have a reasonable basis for treating workers other

than employees.(35)

The legislative descriptions of the reach of section 530 as including "taxpayers involved in controversies with the Internal Revenue Service" on their face to apply with equal force to both public and private employers. Again, there is no suggestion in the legislative history that Congress was distinguishing between public and private employers.

The Conference Report on the Tax Reform Act of 1986 is particularly important in this respect. One day before Congress passed the Tax Reform Act, it approved the Budget Reconciliation Act of 1986 which amended section 3121(b)(7)(E) to impose FICA tax liability on state and local governments.(36) The Conference Report of the Tax Reform Act of 1986 speaks in the present tense of "taxpayers who in the past had a reasonable basis (such as past industry practice) for not treating workers as employees."(37) These taxpayers are eligible for section 530 relief. At the time it spoke of "taxpayers," Congress must be deemed to have been aware of its own action in the Budget Reconciliation Act, which included public entities within the realm of taxpayers subject to FICA tax. In addition, Congress was presumably aware, all the way back to 1978, that public entities were subject to the employee income tax withholding.

To whatever extent the IRS can hang its hat on the FICA tax's not being technically imposed as a tax on public employees, it encounters a more difficult problem with respect to income tax withholding on wages. Under chapter 24 of subtitle C, a taxpayer is liable for withholding from wages of employees "a tax determined in accordance with tables or computational procedures prescribed by the Secretary."(38) The taxpayer's liability for this tax is imposed directly by statute. A public entity's liability for income tax withholding existed under subtitle C before the 1978 enactment of section 530 and is substantially the same as the liability of a nongovernmental employer.(39)

Section 530's legislative history states that "employment taxes under subtitle C" includes employer withholding of employee income tax:

Liabilities terminated under this bill are those for

Federal income tax withholding, social security

(FICA), and unemployment (FUTA) taxes . . .(40)

Congress clearly contemplated that taxpayers subject to withholding tax liability were within the scope of section 530 of the 1978 Act.

TAM 9151004 addresses the historic application of withholding tax liability under subtitle C to public employers by stating that:

At the time section 530 was enacted, government

employers were required only to withhold income

tax from the wages of employees, which, under section

3402(d) is abatable if, for example, the employee

paid his taxes. In other words, the employer has

only a secondary liability under Chapter 24 of subtitle

C.

The technical advice memorandum suggests here that the withholding tax may not be a "tax," that falls on the employer because there is no liability to the extent the employee directly pays his or her income tax liability.(41) This is nonsense. Section 3401(a)(1) of the Code describes employer income tax withholding as a "tax," and that tax is imposed by subtitle C. The employee income tax withholding thus falls within the language of section 530 and has been the subject of section 530 since the date of its enactment in 1978.

In addition, the IRS's argument that because the withholding liability is abatable it is not a subtitle C tax proves too much. The analysis, if correct, suggests that section 530 relief is not available to employers in the private sector with respect to withholding taxes.(42) The withholding provisions and rebate provisions for employer withholding of employee income taxes apply without distinction to private and public employers. If the employee income tax withholding's being abatable removed it from the definition of a subtitle C tax for purposes of section 530, section 530 relief would not be available to either private or public employers. That is simply not the case. In sum, the statute does not permit the distinction advanced by the IRS.

There is no question that, at the time section 530 of the 1978 Act was enacted, state and local governmental employers were liable under subtitle C for at least one of the taxes subject to section 530 relief. There is also no question that, after the 1987 and 1990 Acts, public employers are taxpayers subject to tax liability under FICA.(43) The presumption in the technical advice memorandum that Congress was unaware of the breadth of the statutory scheme when it enacted section 530 is troublesome. Congress's failure to discriminate between private and public sectors in either the language of section 530 or its legislative reports does not leave room for a presumption that the obverse was intended.

In the face of the clear statutory language and the absence of even a hint to the contrary in the legislative history, what justification can the IRS draw upon to deny section 530 relief in the public arena? One explanation is that the IRS opposed the enactment of section 530 in 1978 and continues to seek to limit its reach. Indeed, section 530 of the 1978 Act was a slap in the face of the IRS's enforcement effort in the employment tax area. Whether or not section 630 is good policy, however, is irrelevant: the provision is the law. Application of section 530 to public entities does not involve interpreting ambiguous statutory language that is coupled with legislative history suggesting that the scope of the provision is limited. There is thus little room for the exercise of agency discretion in applying the statute.

The IRS might argue that allowing a public entity to avoid tax by misclassifying workers as independent contractors violates public policy. Seeking relief under section 530 of the 1978 Act, however, is not tax evasion and does not involve a failure to comply with law. Once again, section 530 is a part of the "law." The policy behind section 530, as expressed in legislative history, is to provide relief to taxpayers where the employer has consistently treated a group of workers as independent contractors. Rightly or wrongly, Congress in enacting section 530 perceived certain hardships to employers as a result of the IRS's aggressive employment tax audits. A public entity is subject to those same hardships regardless of its status as a public entity. A public entity has the same problem of large accumulated tax liabilities on which it may not be able to claim abatement because it may not be able to obtain information from its employees.(44) The public entity is thus within the category of taxpayers described by Congress in justification of its enactment of section 530. In addition, application of the common law factors to define employee status is as confusing for a public entity as it is for a private employer. There is no violation of public policy in extending to a public sector taxpayer the relief that Congress granted to similarly situated employers.

Finally, there is an argument that section 530 relief should be denied because governmental entities are not in competition with others to provide services to the public. The premise that public entity employers do not compete in the marketplace is incorrect in some circumstances, particularly in the case of hospital services such as those provided by the taxpayer involved in TAM 9151004. In addition to competing for patients, a public entity hospital competes with private sector hospitals to attract the physicians and other professional staff necessary to its operation. More important, competition has nothing to do with the application of section 530. The competitive or anti-competitive effects of section 530 were not raised as a concern of Congress in any of the legislative history predating the Tax Reform Act of 1986. In 1986 Congress did exclude technical service workers from section 530 relief, arguably because some employers who had historically treated their technical service workers as employess were at a competitive disadvantage with those who had more aggressively treated workers as independent contractors.(45) In the case of a public sector hospital, where groups of workers (particularly physicians) have been historically treated as independent contractors because of notions of professionalism and, to a degree, provisions of state law, the denial of section 530 relief to the public entity places the public entity taxpayer at a competitive disadvantage.

Conclusion

Both the literal language of the statutory scheme and the legislative history of section 530 encompass a public entity as a party for whom section 530 relief is available. In a different context involving FICA tax liability, the United States Court of Appeals for the Federal Circuit stated that, "[t]he government must, in fact, rely on the entirety of the income tax code . . ."(46) Absent some express transition rule, neither the Government nor the taxpayer should be allowed to pick and choose among the parts of a statutory scheme depending upon when the taxpayer became subject to that statutory scheme.

Section 530 of the 1978 Act is a part of the statutory scheme of subtitle C of the Code insofar as section 530 effects the definition of an employee whose wages are subject to subtitle C taxes. A public entity is a subtitle C taxpayer, predating enactment of section 530 with respect to employee withholding and, after 1986, with respect to FICA tax. The definition of an employee is crucial to both of those taxes, and section 530 is an integral part of that definition. The taxes of subtitle C cannot be applied to any taxpayer, public or private sector, without resort to the section 630 rules when they are applicable to the particular taxpayer's case.

(1) Public Law. No. 95-600, [section] 530, 92 Stat. 2689, 2886 (1978). (2) Sept. 4, 1991, 1991 PRL Lexis 2038. (3) See Rev. Rul. 87-41, 1987-1 C.B. 296 and Treas. Reg. [sub section] 31.3401(c)-1 and 31.3401(d)-l. (4) Public Law No. 95-600, [section] 530(c)(1), 92 Stat. 2689, 2886 (1978). (5) I.R.C. [section] 3402(a)(1). (6) I.R.C. [sub section] 3101, 3102, 3111. (7) I.R.C. [section] 3301. (8) I.R.C. [sub section] 1401-1403. The tax is 15.3 percent of self-employment income for the taxable year. I.R.C. [sub section] 1401(a) and (b). The tax is mitigated to some extent for tax years after 1989 with an income tax deduction for 50 percent of self-employment taxes an a trade or business expense. I.R.C. [section] 164(f). (9) Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, at 1343 (1987). (10) H.R. Rep. No. 95-1748, 95th Cong., 2d Sess. 3 (1978), reprinted at 1978-3 C.B. 631. (11) Id. (12) I.R.C. [section] 3402(d). (13) H.R. Rep. No. 96-1748, supra note 10, at 3. (14) Id. at 4. (15) Id. (16) Public Law No. 96-167, [section] 9(d), 93 Stat. 1275, 1278 (1979), extended the effective date through January 1, 1981; Public Law No. 96-541, [section] 1(a), 94 Stat. 3204 (1980), extended the effective date through January 1, 1982; and Public Law No. 97-248, [section] 269(c), 96 Stat. 324, 562 (1982), extended the application of section 530 indefinitely. Section 530 of the 1978 Act was amended by Public Law No. 99-514, [section] 1706, 100 Stat. 2085, 2781 (1986), to exclude certain "technical service workers" from coverage under section 530. (17) I.R.C. [sub section] 3121(b)(7)(E) and (F). (18) I.R.C. [section] 3306(c)(7). (19) I.R.C. [sub section] 3402, et. seq. (20) Public Law No. 95-600, [section] 530(c)(1), 92 Stat. 2689, 2886 (1978). (21) I.R.C. [section] 3101(a). (22) I.R.C. 3102. (23) See I.R.C. [sub section] 3121(b)(7)(A)-(D). (24) 42 U.S.C. [section] 418. (25) 42 U.S.C. [section] 418(a)(1). (26) Public Law No. 99-509, [section] 9002(b), 100 Stat. 1874, 1971 (1986). The amendment applies to remuneration paid after December 31, 1986. Public Law No. 99-509, [section] 9002(d). (27) Pub. L. No. 101-508, [section] 11332(b), 104 Stat. 1388, 1388 - 469 (1990). I.R.C. [section] 3121(b)(7)(F) is effective with respect to services performed after July 1, 1991. (28) Public Law No. 95-600, supra note 20, [section] 530(c)(1). (29) See text accompanying note 19 supra. (30) H.R. Rep. No. 95-1748, supra note 10. (31) See text accompanying note 10 supra. (32) H.R. Rep. No. 95-1748, supra note 10, at 3. (33) Id. at 4. The reference to "certain taxpayers" in this and other legislative histories describing section 530 refers to taxpayers who, with a reasonable basis for doing so, have consistently treated workers as independent contractors. (34) S. Rep. No. 96-433, 96th Cong., lst Sess. 12 (1979) with respect to Pub. Law 96-167, [section] 9(d), supra note 16; S. Rep. No. 96-1007, 96th Cong., 2d Sess. 3 (1980) with respect to Public Law No. 96-541, [section] 1(a), supra note 16; H.R. Rep. No. 97-760, 97th Cong., 2d Sess. 650 (1982), with respect to Public Law No. 97-248, supra note 16; H.R. Rep. No. 99-841, 99th Cong., 2d Sess. II-834 (1986), with respect to Public Law No. 99-514, [section] 1706, supra note 16. (35) S. Rep. No. 96-433, supra note 34, at 12. (36) Public Law No. 99-509, supra note 26, [section] 509, adding I.R.C. [section] 3121(b)(7)(E). (37) H.R. Rep. No. 99-841, supra note 34, at II-834. (38) I.R.C. [section] 3402(a)(1) (emphasis added). (39) The only difference is section 3404 of the Code, which identifies governmental personnel responsible for returning amounts withheld. (40) H.R. Rep. No. 95-1748, supra note 10, at 632-633 (emphasis added). (41) See I.R.C. [section] 3402(d). (42) The language of section 530 strictly limits its application to relief from employment taxes under subtitle C of the Code. Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, supra note 9, at 1343. If employee withholding in not a subtitle C tax, then section 530 in not applicable to issues involving its imposition - a ridiculous proposition. (42) Although the question is moot after 1986, it is unclear whether section 530 relief was available before 1987 to a public entity subject to a section 218 agreement. Those agreements generally provided that the public entity "will pay to the State ... amounts equivalent to the sum of taxes (employer-employee contributions) which would be imposed under the Federal Insurance Contributions Act if the services of employees covered by the application and agreement constituted employment as defined in such Act." Presumably, the FICA equivalent liability under this agreement would be computed by incorporating revisions to chapter 21 of the Code subsequent to execution of the agreement. The section 218 agreement requires reference to "employment" under FICA for purposes of computing the taxpayer's liability. Section 530 operates in certain circumstances to define employment for FICA purposes. (44) The extent of this liability is mitigated by the 1982 enactment of I.R.C. [section] 3509. Nonetheless, section 630 was retained after enactment of section 3509 in recognition of the fact that employee classification issues continue to create difficulties for taxpayers. (45) See Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, supra note 9, at 1343. References to competition, however, do not appear in any of the committee reports on the 1986 Act. (46) Anderson v. United States, 929 F.2d 648, 653 (Fed. Cir. 1991).