Employee or Contractor?
"The Definition Is Changing-- Again!"
© by Greta P. Hicks, CPA
"For nearly 20 years, the IRS has been prohibited by law from
issuing any guidance regarding employment tax status," Commissioner
Richards said. In 1986 and in 1995, when this author attended the White
House Conference on Small Business, the employee versus contractor issue
was discussed at length by irate businesses owners. It appears that the
IRS has at last heard our complaint. In a March 18 announcement, IRS Commissioner
Richardson stated, "People have complained about the uncertainty that
results from worker classification under the (20) common law standard(s),
yet we (the IRS) are prohibited from issuing guidance that is more up to
date. I believe that these initiatives we are announcing today will help
ease some pressures that both the business community and the IRS face."
The IRS announced on March 18, 1996 that they are suspending employee-independent
contractors audits for the next few months and they have developed new
audit training manuals and employment tax audit guidelines. Also included
in this announcement is a "let’s make a deal" settlement offer.
Whether a worker is defined as an employee or independent contractor
is a matter of a complex set of 20 common law factors plus interpretations
by numerous court cases. Back in the late 70’s the courts and IRS audit
teams were overwhelmed with mountains of audits related to the definition
of an employee. A cry went from businesses to Capital Hill and Congress
passed Section 530 of the Revenue Act of 1978. Companies received a brief
reprieve from employment tax audits until the late 80’s and early 90’s
when the IRS began re-attacking the employee versus contractor issue. Now,
with the IRS audit teams again being in a quagmire over the issue, the
IRS has taken the initiative to more clearly define employee and to offer
those businesses already under audit an alternative to bankruptcy.
The most recent suspension of employee versus contractor audits is
to given the IRS time to train auditors in field on the new manual procedure
related to worker reclassification. The training materials will focus on
defining an employee by determining the control the company has
over the workers. The materials discuss the control factors under
the 20 common law standards and guides auditors in determining which of
those 20 factors are relevant. The IRS defines control as:
Anyone who performs services is an employee if you, as an employer,
can control what will be done and how it will be done. This is so even
when you give the employee freedom of action. What matters is that you
have the legal right to control the method and result of the services.
A draft copy of the new manual on worker reclassification can be
obtained..free. Write Dean, IRS School of Taxation, CD:TX, 2221 S. Clark
St., Arlington, VA 22202.
Section 530 of the Revenue Act of 1978, prohibited the IRS by law
from issuing any guidance regarding employment tax status and proposed
several "safe-harbor rules" for companies who were under employment
tax audits. Roughly, Section 530 passed by Congress in 1978 said, "IRS
lay off until we (Congress) defines an employee." Here 18 years later,
Congress has not define employee and has prohibited the IRS from issuing
any regulations on the subject.
Over the years, the IRS interpretation of the "safe-harbor rules"
has gone from liberal to conservative. In 1979 and 1980 on most employment
tax audits, the IRS allowed company’s to fall under the safe-harbor rules.
But during the era of the "no new taxes," the IRS began a ultra
conservative interpretation of Section 530 and it was near impossible for
any company under IRS employment tax audit to claim the safety of Section
On March 18 the IRS announced that they are establishing new procedures
that will ensure that auditors properly apply the taxpayer relief provisions
under Section 530 of the Revenue Act of 1978. The new policy on application
of the safe-harbor rules will be more liberal and allow more companies
to rely upon Section 530 safe havens.
Let’s Make A Deal
The most significant aspects of the March 18 announcement details
the two new expedited procedures for companies whose existing worker classifications
are being questioned by the IRS.
First, the IRS is establishing new procedures under an optional classification
settlement program that will allow companies and auditors to resolve contractor
versus employee issues earlier in the audit process.
For example, companies that filed Form 1099, Information Returns,
but failed to meet the other two requirements under Section 530 safe-harbor
rules, could reclassify their workers to employees prospectively and pay
only a specified tax assessment not exceeding one year’s liability. The
amount of the assessment would depend on the extent to which the company
has satisfied the safe-harbor requirements under Section 530.
Secondly, the IRS has expanded procedures developed last year to
allow companies to, at their option, to appeal employee versus contractor
issues to the IRS Appeals function even while an audit is in progress.
This procedure, which is a part of the taxpayer rights initiatives the
IRS announced earlier this year, is designed to resolve employee versus
contractor issues earlier in the audit process.
On March 5, 1996, the IRS began a two year test period of the classification
settlement program. A one years test of the early referral to Appeals procedures
begins on March 18, 1996.
During the suspension of the employee versus independent contractors
audits, the IRS will be training field office personnel on the new expedited
procedures for companies currently under audit. This author believes that
the because the training has not been budgeted for during the current fiscal
year, the training will not take place until after October 1, 1996, the
beginning of the next fiscal year’s budget. The effect of budget constraints
will be to put on hold any existing audits or appeals until after the training
of field personnel. The date of the training will vary across the county
depending upon other budgetary demands of local offices.
Under this new policy, the IRS will waive much of the back taxes
it asserts that companies owe. For many companies that have been consistent
in how they classify their workers, the IRS will let them to shift to employee
status without penalties for prior years. This policy is consistent with
other recent policy changes which focus on future compliance of companies
rather than concentrating heavily of punishment for past non-compliance
with the laws. Although not a solution for every company, it is a beginning
step to settlement.
For More Information
Call the IRS at 1-800-TAX-FORM and ask for Publication 937, Business
Reporting, and for Form SS-8, Information for Use in Determining Whether
a Worker is an Employee for Federal Employment Taxes and Income Tax Withholding.
The purpose of the SS-8 is for workers and companies to answer the questions,
mail the SS-8 to their Service Center, and receive back a Private Letter
Ruling from the IRS on the status of the company’s worker(s).. Do not take
these questions lightly. Secure a copy of the SS-8 for yourself. The questions
are worded in such a way that most all workers are employees. Occasionally,
the IRS Revenue Officers requests that companies complete SS-8. Professional
tax advise should be sought before submitting this or other forms to the
Who Is An Employee?
The IRS Definition
The Internal Revenue Service uses these criteria to determine whether
an individual is an employee or an independent contractor. The worker is
an employee if...
- You or your representative tells the worker where, when, and how
- You train the worker.
- The business performance depends on the worker.
- The worker has a continuing relationship with the company.
- The worker’s services must be personally rendered by the him/her.
- You set the worker’s work hours.
- The worker works on the employer’s premises.
- You are paid by the hour, weeks, or month.
- You furnish tools and materials.
- You can fire the worker without violating a contract.
- The worker has a right to quit without incurring a liability.
- The worker does not offer the worker’s services to the public at
- The worker has no opportunity for profit or loss as a result of the
- The worker has no significant investment in the business.
- You require the worker to submit oral or written reports.
- The worker is a corporate officer.
Section 530 Safe Harbor Rules
Section 530 provides certain safe-harbor rules. If you could fall
under these safe-harbor rules, the IRS could not re-define the worker as
a employee. In general if, the
- company treated in individuals consistently as a contractor, and
- company was in full compliance by filing all required forms such
as Form 1099, and if, the
- company could rely on one of three basis for their practice of carrying
the worker as a contractor
- Judicial precedent (A court case in the company’s favor)
- Past IRS Audit (A past IRS audit determine the worker to be a contractor)
- Industry Practice (There is a long-standing recognized practice
of treating such workers as contract)
- then, the IRS could not change the status of the worker to employee.
20 Common Law Factors
- Service rendered personally
- Hiring, supervising, and paying assistants
- Continuing relationship
- Set hours of work
- Full-time work required
- Doing work on business owner’s premises
- Accomplishing work in certain order or sequence
- Submission of oral or written reports
- Method of payment
- Payment of business or traveling expenses
- Furnishing tools and equipment
- Significant investment
- Realization of profit or loss
- Work for one entity at a time
- Offer their services to the general public
- Right to discharge
- Right to terminate
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List of Articles by Greta P. Hicks, CPA
GRETA P. HICKS, CPA and former IRS manager, concentrates in solutions to IRS problems and advises business and tax professional on IRS policies
and procedures. Ms Hicks is owner of TAX SOLUTIONS, Inc., a company providing
educational materials and programs on solutions to IRS problems and is
a nationally known speaker and writer on solutions to IRS problems. To
arrange for consultation contact:
Greta's web site: http://www.gretahicks.com
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