Federal Employment Taxes: Employee-Independent Contractor Issues (Part 5)

Section 530 Relief

Employers that have workers which the employer classifies as "independent contractors" (Form 1099) risk having these workers reclassified by the IRS as employees. This is a major audit area for the IRS. If the IRS does audit an employer, and reclassifies "contractors" as "employees" this will subject the employer to substantial federal employment tax liabilities, penalties, and interest, and the employer will also be required to treat the "reclassified" contractors as employees going forward.

If an employer is audited by the IRS, the IRS will generally find that an employer/employee relationship exists when the employer has the right to control and direct the worker, not only as to the result to be accomplished by the work but also as to the details and means by which that result is to be accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but as to how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if the employer has the right to do so. The IRS will often use a "20-factor test", developed through court decisions, in making its determination of employee status.

Section 530 Relief

  • Section 530 of the Revenue Act of 1978, was adopted by Congress to provide employers with relief who have treated workers as independent contractors.
  • Section 530 is not part of the Internal Revenue Code (26 U.S.C.), and, as such, has not been adopted by most states which often adopt applicable provisions of the Internal Revenue Code for state tax purposes.
  • If Section 530 relief is available to an employer, the employer's workers will not be treated as employees for federal employment tax purposes.
  • If an employer asserts in an IRS audit that Section 530 relief may be applicable, the IRS examiner must first consider the Section 530 claim before examining other worker classification issues. IRS examiners are also required to now first explore whether Section 530 relief may be applicable, even if not raised by the employer. Relief can be available to an employer under examination, and the employer need not concede or agree to the determination that any workers are employees in order to qualify.
  • Once a claim for Section 530 relief is raised or otherwise identified in an IRS audit, the IRS examiner must exercise caution to ensure that requests for information from the taxpayer are relevant to the Section 530 claim and reasonable.
  • For Section 530 to be available to an employer, the following requirements must be met:
  • The employer consistently treated the workers (and any individuals holding a substantially similar position) as nonemployees for employment tax purposes for the tax periods at issue and all prior tax periods after 1978;
  • The employer filed all returns required for the workers for those periods and all periods after 1978 and the returns were consistent with nonemployee status (e.g. Forms 1099 as opposed to Forms W-2); and
  • The employer had a "reasonable basis" for treating the workers as nonemployees. Section 530 provides three "safe havens" for establishing a reasonable basis for treating workers as nonemployees. A taxpayer may also establish other reasonable grounds for its classification. The safe havens under Section 530 provide that "reasonable basis" for contractor classification of a worker is established if the taxpayer reasonably relies upon any of the following:

(1) Judicial precedent, published rulings, or IRS technical advice or letter ruling to the taxpayer;

(2) A past IRS employment tax audit in which no assessment was made on account of improper classification of workers holding substantially similar positions; or

(3) A long-standing recognized practice of a significant segment of the industry in which the worker worked.

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