In September 2011 the IRS announced a new voluntary classification settlement program (VCSP) providing partial relief from retroactive federal employment tax assessments for eligible taxpayers that agree to prospectively treat their workers, or a class or group of their workers, as employees (see “Tax Matters: IRS Offers Employee Reclassification Agreement,” JofA, Dec. 2011, page 59). This program may be a good option for some taxpayers who are worried about a possible assessment of employment taxes for previous years.
However, the VCSP is not a taxpayer’s only defense against a retroactive assessment of employment taxes. Taxpayers that treat their workers as independent contractors may still prevail in an IRS challenge to their worker classifications and avoid retroactive employment tax assessments if they qualify for relief under Section 530 of the Revenue Act of 1978.
Section 530 states in part that an individual will not be considered an employee if a taxpayer treated him or her and other workers performing similar tasks as nonemployees for all periods, had a reasonable basis for doing so, and filed required information and other returns (such as Form 1099-MISC) consistently with that status. A taxpayer is deemed to have had a reasonable basis for not treating an individual as an employee if the taxpayer reasonably relies on:
- Judicial precedent, published rulings, or technical advice with respect to the taxpayer, or a letter ruling to the taxpayer;
- A past IRS audit of the taxpayer in which there was no assessment attributable to the treatment (for employment tax purposes) of the individuals holding positions substantially similar to the position held by this individual; or
- Long-standing recognized practice of a significant segment of the industry in which the individual was engaged.
To help define “long-standing” and “significant segment,” Congress provided (Section 530(e)(2)) that taxpayers need not show that a practice has been in effect more than 10 years or that more than 25% of an industry (not including the taxpayer) engages in that practice. In keeping with Congress’s intent that these provisions be construed liberally in favor of taxpayers (Joint Committee on Taxation report JCX-26-07, May 7, 2007), courts have given wide latitude in interpreting those and other terms of the safe harbor.
For example, in General Investment Corp., 823 F.2d 337 (9th Cir. 1987), the taxpayer showed that it met the long-standing practice standard because it had treated its workers as independent contractors since acquiring a mining operation, as had the operation’s previous owners. The company also provided evidence that several dozen small mining operations in the area treated their workers as independent contractors. The Ninth Circuit found that proof of nationwide practices was not necessary.
In RI Unlimited, Inc., T.C. Memo. 2010-205, the taxpayer relied on the statement of four individuals with experience in the industry to show that it was entitled to relief under the long-standing practice safe harbor.
In McClellan, 900 F. Supp. 101 (E.D. Mich. 1995), the taxpayer surveyed 41 companies that hired flooring installers to obtain evidence of a long-standing industry practice of treating them as independent contractors. Even though the IRS argued that McClellan’s decision to treat his own workers as independent contractors could not have been based on the survey, which was conducted after the years in question, the court found in his favor.
A taxpayer may be able to show a long-standing industry practice for treating workers as independent contractors if there is evidence that the IRS has essentially approved of the treatment as an industry practice. In Marlar, Inc., 151 F.3d 962 (9th Cir. 1998), the IRS had audited a competitor of Marlar that conducted its business in much the same way and had approved of the competitor’s classification of its workers as nonemployees.
In addition to the safe-haven standards specified in Section 530(a)(2), a taxpayer is entitled to relief when it can demonstrate any other reasonable basis for treating its workers as independent contractors. The courts have liberally construed “any other” reasonable basis in favor of the taxpayer. In Peno Trucking, Inc., 296 Fed. Appx. 449 (6th Cir. 2008), the Sixth Circuit found that the taxpayer’s reliance on the findings of a workers’ compensation audit conducted during the taxpayer’s early years of business met the requirement.
Editor’s note: This article is adapted from “Section 530 Relief for Worker Classification Controversies,” in The Tax Adviser, June 2012, page 380.
By Claire Y. Nash, CPA, Ph.D., (firstname.lastname@example.org) an assistant professor of accounting at Florida Atlantic University in Boca Raton, Fla.
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