Employment Tax Audits - Employee Reclassifications and Section 530 Relief

When your client is facing a possible worker reclassification, practitioners should try utilizing 530 relief for their client. Qualifying for 530 relief will severely limit the amount of employment taxes the IRS can impose on your client. The following is a law analysis section on Section 530 relief:

Section 530(e)(3) of the Revenue Act of 1978, as amended by the Small Business Job Protection Act of 1996, clarifies that the first step in any case involving whether the business has the employment tax obligations of an employer with respect to workers is determining whether the business meets the requirements of section 530. If so, the business will not have an employment tax liability with respect to the workers at issues.

 

Section 530(a)(1) provides, in part, that if, for purposes of employment taxes, the taxpayer did not treat an individual as an employee for any period, then for purposes of applying such taxes for such period with respect to the taxpayer, the individual shall be deemed not to be an employee, unless the taxpayer had no reasonable basis for not treating the individual as an employee.

 

This relief applies only if both of the following consistency rules are satisfied: 1) all federal tax returns (including information returns) required to be filed by the taxpayer are timely filed on a basis consistent with the taxpayer's treatment of the individual as not being an employee ("reporting consistency"), and 2) the taxpayer (and any predecessor) has not treated any individual holding a substantially similar position as an employee for purposes of employment taxes for periods beginning after December 31, 1977 ("substantive consistency rule").

 

Section 530(a)(2) sets forth three safe havens in determining whether a taxpayer has a reasonable basis for not treating an individual as an employee. They are reasonable reliance on: (A) judicial precedent, published rulings, technical advice with respect to the taxpayer, or a letter ruling to the taxpayer; (B) a past Internal Revenue Service 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 (C) long-standing recognized practice of a significant segment of the industry in which such individual was engaged. A business which fails to meet any of three safe havens may nevertheless be entitled to relief, if the business can demonstrate, in some other manner, any other reasonable basis for not treating the worker as an employee.

 

In Bruecher Foundation Services, Inc. v. U.S. (484 F.Supp.2d 600), a case where the taxpayer’s filed 1099’s two days before the court date, the court held, “taxpayer's filing of its returns only after the IRS challenges the classification of its workers fails to demonstrate the good faith that Congress sought to require by demanding that a taxpayer file the appropriate tax returns. See, e.g. Boles Trucking v. United States, 77 F.3d 236, 239 )8^th Cir. 1996), (identifying legislative intent to protect taxpayers misclassifying workers in “good faith”); Gen Inv. Corp. v. United States, 823 F2d337, 340 (9^th Cir. 1987) (“[w]ithout question, Congress intended to protect employers who exercised good faith in determining whether their workers were employees or independent contractors” ); Cf. Med. Emergency Care Assocs., S.C. v. Comm'r, 120 T.C. 15, (2003) (granting Safe Harbor relief where taxpayer filed untimely information returns but mailed returns before audit commenced). Interpreting a late filing such as Bruecher's as satisfying the filing requirement would thus defeat the purpose of such requirement.”

 

“Individuals… who may not be reclassified are those whom the taxpayer has treated in good faith as independent contractors for employment tax purposes. The taxpayer shall be deemed to have acted in good faith only if all Federal tax returns (including information returns) required to be filed by the taxpayer were filed on a basis consistent with a taxpayer’s treatment of such individuals as independent contractors and the taxpayer treated such individual contractors in reasonable reliance…” S.REP No. 95-1263 at 210 (1978)

 

As such, filing 1099’s must be filed in good faith.

Relevant Citations:

Publication 1976