Independent Contractor or Employee?

BY DEBRA M. JOHNSON

  

 
 

A recent congressional inquiry into whether Blackwater USA properly classified its security guards in Iraq and Afghanistan as independent contractors rather than employees highlights the often complicated application of provisions for determining this status. In its defense, Blackwater invoked the safe-harbor provisions of section 530 of the Revenue Act of 1978, among other arguments. Advisers to businesses dealing with this common dilemma may want to make sure they know the safe-harbor rules, which are not written into the Internal Revenue Code but may be found in source notes for IRC section 3401.

Other contractor versus employee considerations include 20 common-law factors and types of evidence for meeting them, as found in Revenue Ruling 87-41, IRS Publication 15-A, the Internal Revenue Manual and IRS training materials.

Section 530 requires:

CONSISTENT TREATMENT
To classify a particular worker as an independent contractor, the taxpayer cannot have treated the worker and others in substantially similar positions as employees for any prior period. To determine whether positions are substantially similar, analyze the relationship between the taxpayer and the worker, including duties, responsibilities, skills and knowledge required.

REASONABLE BASIS
A reasonable basis for treating the worker as an independent contractor can be claimed within one of four categories: (1) judicial precedent, published rulings, or a letter ruling or technical advice to the specific taxpayer; (2) past employment tax audit of the taxpayer; (3) long-standing recognized practice of a significant segment of the industry; or (4) any other reasonable basis.

CPAs advising employers may find conflicting court decisions or not be able to find a decided case that fits the client’s facts and circumstances. If you ask for a letter ruling determining worker status, you will then be held to the Service’s decision in the letter ruling, and the IRS favors employee status. If employers have had a past employment tax audit and their independent contractors’ statuses were not challenged by the IRS, they should ensure that they meet the other safe-harbor requirements.

A fixed length of time is not required for an industry segment to be considered to have a long-standing, recognized practice of using independent contractors. Nor does “significant segment” require a specific percentage of the industry. However, if the segment of the industry supporting the classification is measured, the IRS cannot require it to be more than 25%. “Industry” will generally be construed to mean businesses competing for the same customers and providing the same or a similar product or service in the same geographic area. Employers might consider conducting a survey to document how their competitors determine whether to treat their workers as independent contractors or employees.

The congressional conference report for the act states that the reasonable-basis requirement is to be construed liberally in favor of the taxpayer; however, some type of documentation is needed. The IRS training material states that the taxpayer may rely on the advice of a trained accountant or attorney as “other reasonable basis.” All four categories of reasonable-basis criteria are subject to the facts and circumstances of a taxpayer’s particular situation.

REQUIRED RETURNS FILED
All returns that are required to be filed for independent contractors must have been filed, especially Form 1099 informational returns. This requirement is tied to the consistent treatment requirement. Medical Emergency Care Associates S.C., 120 TC 436, held that the plain language of section 530 does not require timely filing of the 1099s. However, the returns have to be filed before the start of an employment tax audit to meet the safe-harbor requirement (see Bruecher Foundation Services Inc., 99 AFTR2d 2007-2653). For compliance purposes, to avoid penalties and to ensure meeting the safe-harbor requirements, file the required 1099 returns when due, if possible.

EXCEPTIONS
The section 530 safe harbor does not apply to engineers, designers, drafters, computer programmers, system analysts or workers engaged in similar work. It also has been held not to apply to “statutory” employees of section 3121(d) but only to “common-law” employees of 3121(d)(2). Joseph Grey v. Commissioner, 119 TC no. 121.

By Debra M. Johnson, CPA, J.D., assistant professor of tax and business law at Montana State University, Billings, Mont. Her e-mail address is djohnson@msubillings.edu.

SPONSORED REPORT

How to make the most of a negotiation

Negotiators are made, not born. In this sponsored report, we cover strategies and tactics to help you head into 2017 ready to take on business deals, salary discussions and more.

VIDEO

Will the Affordable Care Act be repealed?

The results of the 2016 presidential election are likely to have a big impact on federal tax policy in the coming years. Eddie Adkins, CPA, a partner in the Washington National Tax Office at Grant Thornton, discusses what parts of the ACA might survive the repeal of most of the law.

COLUMN

Deflecting clients’ requests for defense and indemnity

Client requests for defense and indemnity by the CPA firm are on the rise. Requests for such clauses are unnecessary and unfair, and, in some cases, are unenforceable.