Section 530 & “Reasonable Basis”
Section 530 of the Revenue Act of 1978 has not been incorporated into the Internal Revenue Code, but it provides a limited safe harbor for employees to prevent the IRS from retroactively reclassifying certain independent contractors as employees. http://www.irs.gov/irm/part4/irm_04-023-005r.html
The purpose of the safe harbor rule is to prevent reclassification in certain situations where the employer has “reasonable basis” for classifying a person as an independent contractor.
Ok, great, so you can read all of this boring legislation. But, you’re probably wondering, what do I do?
In order to qualify for relief under Section 530 safe harbor, you (as an employer) must satisfy three tests:
- You must have a reasonable basis for treating the individual as an independent contractor;
- You must consistently treat all similarly-situated workers as independent contractors (the “substantive consistency” requirement);
- All of your tax returns must have been filed on a basis consistent with independent contractor classification (the “reporting consistency” requirement). *The Tax Court has found that the untimely filing of a taxpayers’ Forms 1099 would not preclude relief under Section 530.
IMPORTANT: You, as the employer, have the burden of proof in showing that you are entitled to this relief.
If you feel this is a material issue in your business, please seek counsel from a CPA (such as myself) or an attorney (such as Mike Sullivan at Taylor English Duma LLP). It’s dangerous to try and apply the law on your own and think you have a case locked up. Remember, you have the burden of proof, which can be a tall order.
Now, let’s park a bit on the concept of “reasonable basis”…..
The courts have found that the “reasonable basis” requirement is satisfied when the employer relies on one or more of the following:
- Judicial precedent, published rulings or IRS letter rulings to the taxpayer (IRS rulings addressed to other taxpayers have been found insufficient) – see Darrell Harris, Inc. v. United States, 770 F. Supp. 1492 (1991);
- A past IRS audit of the employer where there was no assessment attributable to the treatment of individuals holding positions similarly situated to the individual at issue for employment tax purposes;
- A longstanding recognized practice of a significant section of the industry in question – see Nu-Look Design v. Commissioner, 356 F.3rd 290 (2004) & Green v. United States, 380 F. Supp. 2d 598 (2005);
- As a catch-all, any other reasonable basis for not treating an individual as an employee.
Does that seem gray? That’s because it is. Often times, whether or not you have an issue with this will depend on the Department of Labor, the agent assigned to your case, their willingness to litigate, etc. Often times the best strategy is to document everything you can, in advance, to prove your Section 530 relief entitlement. And, then, let a great attorney be your super hero and stand between you and the government. This is not an issue to be cavalier about. It can be very costly if you run into an over-zealous agent for the Department of Labor or other government agency. Remember, you, as the employer, have the burden of proof.
If you think the purpose of the rules is to punish good, hard-working business owners, I don’t think that is the intent. The intent of the rules is to protect unsophisticated, innocent workers in the U.S. from being classified as independent contractors such that unethical business owners cannot try and stick them with the payroll tax burden, rather than splitting it between the two of them (50% employer, 50% employee). I don’t necessarily disagree with the concept, but in practice, I have seen that the “burden of proof” has really been taken too far. It seems to be much too difficult for employers to meet this legal concept.
SOME OTHER CONSIDERATIONS AND HOW THE COURTS HAVE RULED:
- The courts have generally protected employers when they have used the outcome of an IRS audit to apply a reasonable transfer of that ruling to other, similar workers, inside the same industry. For example, if a ruling is in the favor of the employer for a landscape worker, then the employer can transfer that ruling to another type of similar contractor in their business. Again, this is, in general, not specifically.
- The courts have typically allowed employers to rely on a “longstanding” custom used by a “significant section” (at least 25% on a nationwide basis) of the industry to establish reasonable basis.
- Sometimes, the courts will allow an employer to get relief based on the employer having some other reasonable basis for the classification. For example, if the employer relied upon advice from a CPA or attorney, that advice can meet the test of reasonable basis. Again, this is in general, it does not mean all the time.
I am a CPA and not an attorney, and I would recommend to anyone with these issues that they consult BOTH their CPA and attorney to talk through positions and strategies related to their specific situation. This article is meant to help you think through these issues and identify issues in your business, it is not meant to allow you to draw specific conclusions that you can rely on.
Dan Lucas, CPA
Credo Financial Services, Inc.