Independent Contractor Safe Harbor Now a Minefield

Yesterday I listened to a webinar put on by the law firm of Smith, Gambrell & Russell. There were multiple topics, but the one part that most caught my attention was conducted by attorney Tracie Johnson Maurer. Her topic was Status of the Independent Contractor Employment Tax Forgiveness under Section 530 of the Revenue Act of 1978. Independent Contractor classification has long been, and still is, an area of consternation for employers. Many a company has run afoul of the IRS by improperly classifying workers as independent contractors when the IRS classified them as employees. (I wrote about this most recently on April 15, 2010 in the IRS and HR: Who is an Employee). Of course we all know the reason the IRS argues for employee status is that it is easier to collect taxes from companies than it is to collect from the independent individual. As you can see from Ms. Maurer's topic head this has been an issue since 1978.


In 1978, in the Revenue Act, and again in 1996 in the Small Business Job Protection Act, Congress tried to clarify the issue by creating a SAFE HARBOR provision that protected companies in certain instances of misclassification. The language of this measure is:

The Revenue Act of 1978 produced 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, 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 contractor 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".

Ms. Maurer makes it clear in her presentation that the safe harbor has limited use and that you still have to use the IRS 20 factor rules and she says "An employer-employee relationship can be established by one factor (i.e., payment of the worker’s social security taxes; the worker provides services solely and on a full-time basis to the employer) or any combination of factors." So it is a tricky path to try to follow. The safe harbor is in effect even if the independent contractor failed to pass the 20 Factor test if they meet three conditions. These are:

1. The business must have filed all required tax returns, including informational reports such as 1099s, consistently with the employer’s treatment of the worker as an independent contractor.

2. All workers holding substantially similar positions must have been treated as independent contractors.

3. There must be a reasonable basis upon which to believe the worker is an independent contractor.

Now, due to budget pressures (you know that multi-trillion dollar debt we now have) there is a new emphasis on making money. The IRS is once again considering revising their interpretation of the laws. According to Ms. Maurer "Federal budget for FY 2011 contains proposed provisions which would allow the IRS to issue regulatory guidance on employment tax classification and to reclassify workers found to have been misclassified even if otherwise prohibited by Section 530." The IRS will have $25 million more to hire more compliance officers and they have already announced they will be auditing 6000 businesses for IC violations.

So be forewarned. Know whether you are properly classifying workers as Independent Contractors. Guidance can be found in this post Independent Contractor: The Devil in Disguise.

The IRS and HR: Who is an Employee?

Here is a little humor to start off TAX DAY.
A man is on his death bed and his best friend is there beside him. The man says to his friend "Fred, I want you to do me a favor. After I am dead and cremated I want you to put my ashes in an envelope and send them to the IRS. And on the outside of the envelope I want you to write a message." Fred asks "What is the message?" The man answers "I want you to write NOW YOU HAVE EVERYTHING."

On this TAX DAY I thought it appropriate to talk about the fact that the IRS exerts a great deal of control over a company or organization that Human Resources must pay attention to, not the least of which is defining who is an employee. The IRS looks at four catagories of people who deliver services to an employer. These include common-law employees, statutory employees, statutory non-employees and, of course, independent contractors. Here is a quick break down:

• Common- Law employee: Under common-law rules, anyone who performs services
  for you is your employee if you have the right to control what will be done and how it will be done. Pretty simple.
• Statutory employees: If workers are independent contractors under the common  law rules, such workers may nevertheless be treated as employees by statute, “statutory employees,” for certain
  employment tax purposes. These workers include some drivers, full-time life insurance agents, some home workers, and traveling sales agents who may sell goods for you and others.
• Statutory non-employees: These include direct sellers, licensed real estate agents, and some companion sitters.
• Independent contractors: These are people over which the employer does not exercise behavioral control or financial control and with whom they have a well-defined relationship.

Who is an independent contractor and who is not is frequently an area of confusion for many employers. While the IRS used to have a 20-factor test, today the more frequently look at the amount of control you have over the person's behavior versus the outcome of their work. They look at how you pay the individual and whether they can work for anyone else at the same time. And they look at whether there is a written contract.
 
The quick and dirty rule is: If it looks like a duck, walks like a duck, quacks like a duck the IRS is going to consider it a duck. And if you have improperly classified your "duck" as a "non-duck" then you are going to owe back taxes and probably penalties for that "duck" and all like "ducks."
 
Here is the IRS's Publication 15-A Employer's Supplemental Tax Guide that offers a pretty understandable definition of each of the catagories listed above, especially that of independent contractor. I would suggest you click on this link, download the document and read it. If you need further help here is a book that might be able to provide some further guidance. Surprisingly Simple: Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less.

Given the aggressive agenda of enforcement that both the USDOL and the IRS have laid out for employers for the next couple of years it is important for HR professionals to understand the wage & hour issues and tax issues that inadverent misclassifications may cause.

You have been warned!