Employee or Independent Contractor? -- Part One
Employee or Independent Contractor? -- Part Two
Worker classification continues to be the issue most frequently mentioned as one of the greatest concerns of smaller businesses and entrepreneurs. Previous columns have examined the newly-published training manual for IRS examiners who evaluate whether workers are employees or independent contractors 1 as well as the "Independent Contractor Tax Simplification Act" introduced in the United States Senate by Senator Christopher ("Kit") S. Bond, Chair of the Senate Small Business Committee, and Senator Don Nickles.2 In summarizing the accomplishments of the 104th Congress, a number of commentaries have appeared in the popular press suggesting that this long-running hassle has now been resolved for the smaller business and entrepreneur. Unfortunately, this is confusing and simply not true.
The "Independent Contractor Tax Simplification Act" was not enacted; thus, this bill has expired, and a new bill will now have to be introduced in the 105th Congress. What was accomplished is that a procedural amendment to Section 530 of the Revenue Act of 1978 was enacted under Section 1122 of the Small Business Job Protection Act of 1996 (H.R. 3448). Let’s look at the impact of this amendment.
The Revenue Act of 1978 promulgated Section 530 to address the controversies that were arising between the IRS and business taxpayers over whether businesses had correctly classified certain workers as self employed -- i.e., independent contractors -- rather than as employees. Section 530 "... generally allows a taxpayer to treat a worker as not being an employee for employment tax purposes (but not income tax purposes), regardless of the individual’s actual status under the common-law test,3 unless the taxpayer has no reasonable basis for such treatment. ... [However, it has been] the position of the IRS, based on legislative history, that section 530 can only apply after a determination has been made that a worker is an employee under the common-law test.
"Under section 530, a reasonable basis for treating a worker as an independent contrac-tor is considered to exist if the taxpayer (1) reasonably relied on published rulings or judicial precedent, (2) reasonably relied on past IRS audit practice with respect to the taxpayer, (3) reasonably relied on long-standing recognized practice of a significant segment of the industry of which the taxpayer is a member, or (4) has any other reasonable basis for treating a worker as an independent contractor. The legislative history states that section 530 is to be ‘construed liberally in favor of taxpayers.’" 4 Regrettably, the interpretations of these safe harbor definitions have differed significantly between taxpayers and the IRS; thousands of costly (and often annihilating) controversies have arisen during the past two decades.
The procedural amendment to Section 530 of the Revenue Act of 1978 enacted under Section 1122 of the Small Business Job Protection Act of 1996 (H.R. 3448) seeks to clarify the interpretations of these safe harbor definitions; it does not supplant either the common-law test or the Twenty Factor Test defined in the IRS Training Manual. The highlights of this amendment stipulate:
- The IRS is to advise the taxpayer of the provisions of Section 530 prior to any audit inquiry;
- The practice of at least 25 percent of an industry shall constitute a "significant segment" of the industry;
- A "long-standing recognized practice" need not "have continued for more than 10 years" (and this is foreshortened for "new" industries) or to have begun prior to 1978;
- A defined basis for shifting the "burden of proof" from the taxpayer to the IRS;
- The applicability of the findings of prior IRS audits as precedent in employee versus independent contractor disputes; and
- Subsequently treating a worker as an employee does not necessarily jeopardize the worker’s status as an independent contractor during prior periods.
While these procedural changes are helpful, they certainly do not reduce the employee versus independent contractor question to the three forthright criteria envisioned in the "Independent Contractor Tax Simplification Act." Consequently, more companies -- large and small -- are now eschewing the direct engagement of independent contractors, and turning to the mature contract staffing services to meet their non-permanent personnel needs. This is especially true for computer programmers, engineers and other technical services workers where companies simply strain to avoid any skirmishes over Section 1706 of the Internal Revenue Code; these contract staffing services assume responsibility for all tax withholdings and other human services benefits. Sadly, this is often unappealing to independent contractors who can no longer craft health, retirement and work-related expenses to conform most economically with their individual family needs.
1 See, "Employee or Independent Contractor? -- Part One," The Business Forum Online. The "IRS Training Guide" titled, Employee or Independent Contractor? was published July 15, 1996.
2 See, "Employee or Independent Contractor? -- Part Two," The Business Forum Online.
3 See, "Employee or Independent Contractor? -- Part One," The Business Forum Online.
4 All quotations are drawn from the Conference Report 104-737, August 1, 1996, accompanying H.R. 3448.
Your comments and suggestions for these pages are most welcomed!
Revised: June 2, 1997 TAF
© Copyright 1997 Thomas A. Faulhaber / The Business Forum Online®, All Rights Reserved