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How employers of independent contractors spell relief.


Employment taxes is one of the areas to which the Internal Revenue Service has turned its attention (and its resources). In 1989, the IRS expressed concern that the misclassification of workers was resulting in the loss of significant amounts of revenue. The IRS has again begun to examine carefully whether certain workers have been properly classified as independent contractors or whether they should be treated instead as employees (with, of course, the resulting increase in reported income and payment of employment and income taxes).


As previous discussion noted, the key element in a worker's status is whether sufficient control is present to establish an employer--employee relationship (see JofA, June89, page 12). To establish this, the IRS has developed a set of factors, based on the common law test of control, to consider in this determination.

Section 530 relief. As might be expected, there have been controversies between taxpayers and the IRS over whether "sufficient control" is present. To resolve some of these, Congress, as part of the Revenue Act of 1978, enacted section 530. Under this provision, a taxpayer is not liable for employment taxes if he (or it) can demonstrate a reasonable basis for treating workers as independent contractors. In addition, section 530 established three types of statutory reasonable basis standards; if any of these is met, the business will not be liable for employment taxes.


Judicial or administrative precedent. A business has met this standard if it reasonably relied on a judicial precedent, published ruling or technical advice or ruling (letter ruling or determination letter, for example) issued to it. The judicial precedent or published ruling does not have to relate necessarily to the particular industry or business.

Past IRS audit. If there was a prior examination in which there was no assessment of taxes, attributable to the treatment of workers in the same (or substantially similar) positions as the workers currently in question, a reasonable basis exists. The past audit need not have been for employment tax purposes; the IRS's failure to make such an assessment, even as part of a routine audit, will qualify. In addition, the audit of a taxpayer doing business in one industry may suffice if that company branches out into another industry, as long as the workers are treated similarly in terms of control, supervision, pay and demands.

Industry practice. If a taxpayer's treatment of a worker coincides with a long-standing, recognized practice of a significant segment of the industry in which the worker was engaged, the taxpayer has a reasonable basis for independent contractor treatment. This standard does not require a practice to be uniform throughout an entire industry. In fact, a "significant segment" may involve a much smaller portion.

Note: These three standards are not exclusive. A taxpayer that can demonstrate a reasonable basis for a worker's treatment in some other manner also may qualify.

Note: Certain technical specialists (such as engineers, designers, draftsmen, computer programmers, system analysts and other similarly skilled workers), who are hired by companies and then supplied to others (through three-party arrangements), must be classified under the general common law rules.


Another requirement for obtaining section 530 relief is consistent treatment of workers by the taxpayer for any period after December 31, 1977. The workers involved (or other workers holding similar positions or performing similar duties) cannot have been treated as employees after this date. In addition, the taxpayer must have filed all appropriate federal returns on a basis consistent with independent contractor treatment (form 1099NEC, for example). These requirements prevent companies from changing the treatment of their workers from employees to independent contractors simply to take advantage of section 530.

For a discussion of the recent developments in this and other areas, see the Tax Clinic, edited by Richard Glennon, in the June 1990 issue of The Tax Adviser.

Nicholas J. Fiore, editor The Tax Adviser
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Title Annotation:from the Tax Adviser
Author:Fiore, Nicholas J.
Publication:Journal of Accountancy
Date:Jun 1, 1990
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