by Benson S. Goldstein, J.D.
Published January 01, 2012
Worker classification issues have become a major tax administration focus in our nation’s capital over the past few months. First, on September 21, 2011, the IRS issued Announcement 2011-64 establishing a new voluntary classification settlement program (VCSP) “that provides partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat workers as employees.” Second, in the same month, the IRS and the Department of Labor (DOL) signed a memorandum of understanding (MOU) to share information regarding employee “misclassification.” And should those actions not prove sufficient, President Barack Obama included a worker classification provision in the September 2011 release of his plan “Living Within Our Means and Investing in the Future: The President’s Plan for Economic Growth and Deficit Reduction.”
Worker classification cases have been a significant bone of contention for the IRS for decades. Businesses that hire workers as independent contractors save money on federal employment taxes, and the independent contractors may view themselves as “entrepreneurial” small-business persons. Determining whether a worker should be treated as an employee or as an independent contractor depends upon a facts-and-circumstances test revolving around a common-law test of whether the service recipient has the right to direct and control how the worker performs the services provided.
IRS revenue agents often take the position that these workers are misclassified and that a business utilizing the skills of these workers owes a large federal employment tax bill. Sometimes the IRS wins such cases against business taxpayers based on the common law; under other circumstances, the Service finds itself stymied from pursuing a case due to Section 530 of the Revenue Act of 1978.
Robert W. Wood, a California attorney, calls Section 530 “a veritable get-out-of-jail-free card that forgives many instances of worker misclassification” (Wood, “Independent Contractor or Employee? The 100-Year War,” 132 Tax Notes 199 (July 11, 2011)). As long as a taxpayer has a reasonable basis for treating a worker as an independent contractor, Section 530 may permit the worker to be treated as a nonemployee.
Under the VCSP, taxpayers may voluntarily reclassify workers as employees for federal employment tax purposes and obtain relief similar to that offered under the current classification settlement program (CSP). To be eligible for the VCSP, the taxpayer must:
Under the September 19 MOU, the DOL’s Wage and Hour Division will share information or data with the IRS related to DOL investigations involving employment tax compliance. In return, the IRS will (1) evaluate and classify employment tax referrals provided by the DOL and conduct employment tax examinations if appropriate; (2) share (when consistent with applicable federal laws) the DOL’s employment tax referrals with state and municipal taxing agencies if approved information-sharing agreements are in place; and (3) share with the DOL annual reports and aggregate data relating to trends in misclassification in a manner that protects return information and taxpayer identities. Both agencies mutually agree to share training materials and participate in joint public outreach events. (For more on the MOU, see this month's Tax Clinic.)
President Obama’s jobs plan for economic growth and deficit reduction, mentioned above, includes a provision that would permit the IRS to (1) issue regulations or other guidance addressing the “proper” classification of workers and (2) require the prospective reclassification of workers who are currently considered misclassified and whose reclassification would otherwise be prohibited under Section 530. The plan would waive penalties for service recipients with a small number of employees and a small number of misclassified workers, if the service recipient has consistently filed all required information returns for its workers and has agreed to prospective reclassification of the workers to employee status.
The only certainty in all this is that the IRS will continue to offer its classification settlement program to businesses that it believes are misclassifying workers as independent contractors. With respect to congressional action on the president’s jobs plan or even a separate worker reclassification bill, the chances of passage during 2012 are unclear, given the upcoming national election and the fact that the Senate is controlled by the Democrats and the House of Representatives is in Republican hands.
Worker classification cases have been a significant bone of contention for the IRS for decades. Businesses that hire workers as independent contractors save money on federal employment taxes, and the independent contractors may view themselves as “entrepreneurial” small-business persons. Determining whether a worker should be treated as an employee or as an independent contractor depends upon a facts-and-circumstances test revolving around a common-law test of whether the service recipient has the right to direct and control how the worker performs the services provided.
IRS revenue agents often take the position that these workers are misclassified and that a business utilizing the skills of these workers owes a large federal employment tax bill. Sometimes the IRS wins such cases against business taxpayers based on the common law; under other circumstances, the Service finds itself stymied from pursuing a case due to Section 530 of the Revenue Act of 1978.
Robert W. Wood, a California attorney, calls Section 530 “a veritable get-out-of-jail-free card that forgives many instances of worker misclassification” (Wood, “Independent Contractor or Employee? The 100-Year War,” 132 Tax Notes 199 (July 11, 2011)). As long as a taxpayer has a reasonable basis for treating a worker as an independent contractor, Section 530 may permit the worker to be treated as a nonemployee.
Under the VCSP, taxpayers may voluntarily reclassify workers as employees for federal employment tax purposes and obtain relief similar to that offered under the current classification settlement program (CSP). To be eligible for the VCSP, the taxpayer must:
- Have consistently treated its workers in the past as nonemployees;
- Have filed all required Forms 1099 for the workers for the past three years; and
- Not currently be under audit by the IRS, the DOL, or a state agency concerning worker classification matters.
Under the September 19 MOU, the DOL’s Wage and Hour Division will share information or data with the IRS related to DOL investigations involving employment tax compliance. In return, the IRS will (1) evaluate and classify employment tax referrals provided by the DOL and conduct employment tax examinations if appropriate; (2) share (when consistent with applicable federal laws) the DOL’s employment tax referrals with state and municipal taxing agencies if approved information-sharing agreements are in place; and (3) share with the DOL annual reports and aggregate data relating to trends in misclassification in a manner that protects return information and taxpayer identities. Both agencies mutually agree to share training materials and participate in joint public outreach events. (For more on the MOU, see this month's Tax Clinic.)
President Obama’s jobs plan for economic growth and deficit reduction, mentioned above, includes a provision that would permit the IRS to (1) issue regulations or other guidance addressing the “proper” classification of workers and (2) require the prospective reclassification of workers who are currently considered misclassified and whose reclassification would otherwise be prohibited under Section 530. The plan would waive penalties for service recipients with a small number of employees and a small number of misclassified workers, if the service recipient has consistently filed all required information returns for its workers and has agreed to prospective reclassification of the workers to employee status.
The only certainty in all this is that the IRS will continue to offer its classification settlement program to businesses that it believes are misclassifying workers as independent contractors. With respect to congressional action on the president’s jobs plan or even a separate worker reclassification bill, the chances of passage during 2012 are unclear, given the upcoming national election and the fact that the Senate is controlled by the Democrats and the House of Representatives is in Republican hands.
EditorNotes |
| Benson Goldstein is senior technical manager (taxation) at the AICPA in Washington, DC, and is staff liaison to the AICPA’s IRS Practice and Procedures Committee. For more information about this column, contact Mr. Goldstein at bgoldstein@aicpa.org. |
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