Alert: The IRS just released more guidance on Sec. 530 relief. In determining whether an individual is treated as an employee, in addition to the usual factors of income tax withholding, filing employer quarterly returns, and filing W-2 forms, the IRS added “contracting with a third party to perform acts required of employers with respect to an individual.” There are also some changes in establishing a reasonable basis for treating a worker as an independent contractor.
You won’t find Section 530 in the Internal Revenue Code. It’s a section in the Revenue Act of 1978. As the IRS states: “Section 530 is a relief provision that terminates a taxpayer’s employment tax liability with respect to an individual not treated as an employee if three statutory requirements are met: 1) reporting consistency; 2) substantive consistency; and 3) reasonable basis.”
What can this relief do…and not do…and how do you get it:
Scope of Section 530 relief
If you misclassify workers as independent contractors when they’re really employees, you can face a slew of tax penalties. These include the failure to withhold and deposit income taxes and the employee’s share of FICA, as well as depositing FUTA taxes and the employer’s share of FICA. An employer’s liability can for employment taxes even be increased where reporting requirements are disregarded. Misclassification can also mean penalties for failing to file the quarterly employer return, Form 941. When interest and penalties are added to back taxes, the financial cost can be devastating. Enter Section 530 relief. This is a way to escape employment taxes as well as related interest and penalties when you treat a worker as an independent contractor, even though the government thinks you should have treated the worker as an employee.
Section 530 relief won’t help you if there’s a question about worker misclassification in other situations:
- Minimum wage and overtime rules. Department of Labor and state labor laws are not subject to Section 530 relief. If a worker is misclassified as an independent contractor, minimum wage and overtime rules apply.
- State and local taxes. For example, if a state wants to you classify a worker as an employee, you’ll owe state unemployment tax, withholding for state income tax where applicable, and other state and local level taxes.
The IRS also says Section 530 relief won’t help if an employer properly treats a worker as an employee but there’s a question about whether payments to the employee are wages. For example, if an employer pays a weekly salary to an employee that been treated as wages for federal employment tax purposes, but also pays a weekly bonus that isn’t treated as such, Section 530 is not applicable because the IRS is not reclassifying the individuals as employees.
How to get relief
If eligible, you may claim relief when you are under audit for worker classification. The auditor is supposed to review applicability of this relief, even if you don’t raise the issue. Whether you ask for relief or the auditor brings it up, be sure to meet 3 criteria listed earlier:
- Reporting consistency. You have always treated the worker in question as an independent contractor, and all workers doing the same work for you are treated in the same manner. There was a class action lawsuit against Microsoft where programmers engaged on a temporary basis were sitting next to programmers who are full-time employees, and a federal appellate court agreed with the temporary workers that they should be classified as employees (entitled not only to proper employment tax treatment, but also back medical coverage and retirement benefits). The company failed in reporting consistency.
- Substantive consistency. You have always filed Form 1099-NEC to report payments to the worker as an independent contractor (assuming payments total $600 or more for the year). The IRS says if a company maintaining that an individual was an independent contractor did not file Forms 1099-NEC “in year 1, but did file Forms 1099-NEC in year 2, the company can’t get Section 530 relief in year 1 but may be entitled to Section 530 relief for year 2 if it otherwise meets the requirements for relief for that year. But relief won’t be denied if a company mistakenly, but in good faith, files the wrong information return (e.g., Form 1099-MISC instead of the required Form 1099-NEC), or didn’t file at all because payments to the worker in the year totaled less than $600.
- Reasonable basis. There is a reasonable basis for treating the worker as an independent contractor. A reasonable basis includes a prior audit on the matter, a private letter ruling to the company, case law, IRS rulings, or a long-standing (10 years) industry practice by a significant segment (25%) of the industry. If all else fails, it may still be possible to show a reasonable basis based on the facts and circumstances of the situation.
If a company establishes a prima facie case (i.e., meets the 3 criteria) and has fully cooperated with the IRS, then the burden of proof with respect to relief shifts to the IRS to show you aren’t entitled to relief.
Final thought
The best course of action is to properly classify your workers so you avoid any employment tax questions linked to worker status. If, despite your best efforts, the IRS successfully challenges how you’ve been treating workers, then be sure to determine whether you qualify for Section 530 relief. Look at IRS Publication 1976, Do You Qualify for Relief Under Section 530. You may also find relief through the IRS’s Voluntary Classification Settlement Program (VCSP). Work with a knowledgeable tax professional if employment tax issues arise.
