Alert
Alert
04.29.11
Legislation is likely to be proposed to increase penalties for Internal Revenue Service worker misclassification audits, reduce availability of Section 530 relief and impose additional requirements for reduced employer withholding under Section 3509. In light of the National Research Program under which 6,000 tax audits on worker misclassification will be initiated over three years, employers should focus on the proposed changes in tax penalties and relief provisions.
Background
In prior years, the tax penalties associated with worker misclassification issues were usually relatively small. Even when penalties were proposed, the IRS Classification Settlement Program often offered employers relief through prospective-only reclassification at reduced rates of withholding. Moreover, Section 530 generally permitted businesses to treat workers as independent contractors where that treatment was both consistently applied and premised on a “reasonable basis,” as defined in the statute.¹
However, in response to various studies concluding that worker misclassification has resulted in a significant “tax gap,”² Congress and the IRS have given increased scrutiny to what they perceived as worker misclassification abuses. As a result, as discussed below, taxpayers can now expect increased penalties on audit and reduced opportunities for mitigating adjustments through settlement.
¹ Section 530 of the Revenue Act of 1978 created a safe harbor allowing employers to continue to treat a worker as an independent contractor even if the worker would have been treated as an employee under common law tests. See Rev. Rul. 87-41, 1987-1 C.B. 296 for a listing of 20 factors reflecting common law tests. To qualify for section 530 relief, an employer must meet the following requirements: (i) the employer must have filed all required returns (e.g., Form 1099) reporting payments to the worker as an independent contractor (reporting consistency); (ii) the employer must have not treated the worker or any similarly situated worker as an employee after 1978 (substantive consistency); and (iii) the employer must have had a “reasonable basis” to have treated the worker as an independent contractor. A “reasonable basis” for treating a worker as an independent contractor would include reliance on judicial precedent, a past IRS audit, industry practice or another reasonable basis for treating the worker as an independent contractor.
² For example, the IRS conducted a preliminary analysis of Fiscal Year 2006 data and found that underreporting attributable to misclassified workers is likely to be “markedly higher” than an earlier $ 1.6 billion estimate based on 1984 data. See, e.g., Treasury Inspector General for Tax Administration, 2009 TNT 25-28 (February 4, 2009).
Download: Worker Misclassification Penalties Likely to Increase as IRS Audits More Employers