In the Worker Classification practice area, we are positioned to assist taxpayers in making important decisions as to the proper classification of workers. Traditionally, employers and workers have struggled in their efforts to determine whether a given individual is properly classified as an independent contractor or employee.
However, in recent years, as LLCs have become a popular entity of choice, LLC employers have struggled in determining whether a given individual is a self-employed partner (for federal tax law purposes) or merely an employee. Quite often, a W-2 is erroneously issued to an individual owning a membership interest in a LLC, even though this person is properly classified as a "partner" for federal tax law purposes. Current Treasury Department proposals are evaluating worker classification issues for S corporation owners. The setting of salaries to properly reflect reasonable compensation may be critical. See, e.g., http://www.salary.com. See also, Fleischer v. Commissioner, T.C. Memo 2016-238 (financial consultant, and not his wholly-owned S corporation, should have reported income received under representative and broker agreements when the service recipient entities were not even aware of the wholly-owned S corporation, having entered into the independent contractor relationship with the financial consultant without even being aware of the financial consultant's S corporation).
No More 20 Factors; IRS Publication 1779 and the Categories of Evidence Approach
Since the enactment of Section 530 of the Revenue Act of 1978, the IRS has been prohibited from issuing regulations or revenue rulings on employment status. Yet, over the years, the IRS attempted to cull together factors it believed was relevant to making worker classification determinations. In 1987, the IRS came out with a 20-factor test, under IRS Revenue Ruling 87-41, but the IRS would eventually have to acknowledge, after years of litigation, that the 20-Factor Test was merely an analytical tool, and not the proper, legal test to be applied in any worker classification dispute. Instead, the legal test focuses on whether there is or is not a right to direct and control the means and details of the work. It soon became apparent to the IRS that the 20-Factor test did not include other factors relevant to the inquiry, like intent of the parties. In addition, there remains some concern that some of the factors utilized by the IRS are derived from “economic reality” tests that derive from Federal laws that are remedial statutes, to be broadly construed in favor of classification as an employee. As the IRS now acknowledges, “some of the 20-factors listed are no longer as relevant as they once were” and “every piece of information that helps determine the extent to which the business retains the right to control the worker is important.” Independent Contractor or Employee, Training Materials, Department of the Treasury (IRS), Training 3320-102 (10-96), at 2-4.
In August, 2008, the IRS issued a new publication, Independent Contractor or Employee…(IRS Publication 1779, noting that classification “affects your eligibility for employer and social security and Medicare benefits and your tax responsibilities.” The IRS claims that courts have considered many facts in deciding whether a worker is an “independent contractor” or an “employee.” The IRS believes that the relevant facts fall into one of three main categories:
- Behavioral Control
- Financial Control
- Significant Investment
- Opportunity for Profit or Loss
- Relationship of the Parties
- Employee Benefits
- Written Contracts
We see how this has played out at times. Take for example what happened in Peterson v. Commissioner of the Minnesota Department of Revenue, in the Minnesota Tax Court, 2010 WL 4181408. There, the Minnesota Tax Court found its own state's statutory definition of "employee" to fail to shed significant light on the distinction between an employee and an independent contractor, and that a factor-by-factor analysis based upon the Internal Revenue Service's Revenue Ruling 87–41 (“Revenue Ruling 87–41”) identifying twenty common law factors, that it would be prudent for the Minnesota Tax Court to use the Minnesota Department of Revenue's summarization of these twenty factors into three main categories in its Withholding Fact Sheet 8 (“Fact Sheet 8”) as being instructive to use in classifying whether those in the cleaning industry are employees.
At the Tufts Law Firm, we know that the categories of evidence approach taken by the IRS is not the law, and can be manipulated. A concern can arise if the IRS is using “economic reality” factors as if they are properly applied to the common law test. Regardless, at the Tufts Law Firm, we understand how worker classification tests utilized by parties can be manipulated, with a results-oriented approach, often times overlooking the fact that employment tax laws are to be construed broadly, in favor of those business owners who make good faith determinations.
SS-8 Review and Analysis (Outside of Audit)
Many times businesses will learn that a Form SS-8 request has been made by a worker for a determination as to the proper worker classification status (i.e., as an employee) under the Federal tax laws.
At the Tufts Law Firm, we are sensitive to the issues that arise when a business receives a Form SS-8 request. This Form SS-8 process used by the IRS is not an audit but it can lead to one. Many business owners do not realize that when they receive the IRS Form SS-8, the situation is a bit of a catch-22. Respond, and find that responses may not properly reflect on the true working relationship. Or, refuse to respond, and have the IRS then pursue an audit. Also, many business owners do not realize that the Form SS-8 is structured to elicit certain responses, using the IRS’ Categories of Evidence approach, but this may not be proper, given the Section 530 protections provided to business owners who have or are making good faith worker classification determinations. Before responding to any Form SS-8 inquiry, please contact us at the Tufts Law Firm for assistance.
Good Faith Worker Classification Under Section 530
Since the IRS no longer relies on the 20-factor test under Revenue Ruling 87-41, and instead, looks to group the gathering of evidence into 3 baskets or categories, business owners must understand how this approach may be manipulated into a results-driven mentality. To be sure, this approach represents an improvement over the 20-factor test, because if properly considers the intent of the parties. However, many practitioners and business owners must be wary of efforts by the IRS to triangulate the approach in ways that runs counter to the common law mandate and spirit of Section 530 of the Revenue Act of 1978.
Section 530 represents an important aspect of legislation that is often overlooked by business owners. It is a remedial statute, aimed at protecting business owners from overzealous efforts on the part of the IRS to re-classify workers, when the business owner has otherwise acted in good faith in making a determination not to classify a given worker as an employee. Under this law, business owners facing the threat of potentially catastrophic retroactive employment tax assessments may seek refuge if they can show that they acted in good faith, showing that they have a reasonable basis, and meet both a substantive consistency and reporting consistency test.
We can provide you with written opinions and legal advice in the area of worker classification in the federal tax arena, to buttress good faith determinations, in anticipation of worker classification determinations. Notably, such opinions/ or advise may be of vital importance for those taxpayers wanting to act in "good faith" reliance when making any worker classification determination, so as to qualify for the protections under Section 530 against catastrophic, retroactive assessments of employment taxes. See, e.g., VTA Management Services, Inc. v. U.S., 95 AFTR 2d 2005-XXXX (E.D.N.Y. 12/14/2004)(Section 530 does not allow for "ex post facto justification"; taxpayer failed to submit evidence sufficient to establish that they did, in fact, rely on the advice of counsel in making its worker classification decision); Nelly Home Care, Inc. v. United States, 185 F.Supp.3d 653 (2016), see also, 2017 WL 1406507 (E.D. Pa. 2017)(Judge Dalzell granted Nelly's motion for summary judgment, concluding that although Nelly was not protected by the statutory industry practice or prior audit safe harbors, Nelly had a reasonable basis for treating its companions as independent contractors, factoring in the cumulative effect of Carney's experience and research, the personal IRS audits which included a review of Nelly's business practices, and Pennsylvania regulations, all of which together provided a reasonable basis for Nelly's decision to classify companions as independent contractors).
Notably, when practicing as a lawyer in North Carolina, Mr. Tufts served as one of the primary attorneys representing the closely-held family taxicab businesses that squared off with the IRS in the 1990s over worker classification issues and a proper application of Section 530. In the cases brought in Federal Court in North Carolina, the taxicab businesses represented by Mr. Tufts faced catastrophic, retroactive employment tax assessments arising from an effort on the part of the IRS to reclassify taxicab drivers operating under lease or independent contractor agreements as employees. There, Mr. Tufts advocated that the IRS was improperly applying “economic reality” principles in its interpretation of worker classification and was furthermore, narrowly construing the provisions of Section 530. The IRS refused to acknowledge in these cases that Section 530 was to be liberally applied, in favor of businesses that have acted in good faith when making worker classification decisions. Instead, the IRS decided that the cases would be “test” cases, on whether Form 1099s had to be filed in order for Section 530 to apply, even if the taxpayer acted in good faith in believing that such forms were not required because no payments were made by it to the drivers. Eventually, the Court ruled in favor of the taxpayers, after a lengthy court battle. The Court found that the taxpayers were at all times entitled to the safe harbor provisions of Section 530, which it observed was specifically enacted as a remedial statute to protect taxpayers from arbitrary action of the IRS which had been evidenced in the past. The taxpayers then sought an award of fees against the Government. The Court found that the taxpayers were credible in believing that the IRS had targeted it, as a small business, to use as a guinea pig, to further its own agenda, in spite of the enactment of Section 530 as a remedy to such action, and per its discretionary authority, granted the taxpayer’s fee request, in excess of the statutory cap. Howard's Yellow Cabs, Inc. v. United States, 1998 U.S.Dist.LEXIS 6055 (W.D.N.C. 1998)(granting request for reasonable litigation costs under 26 U.S.C. § 7430, in the amount of $131,328.42, plus underlying refund of remitted employment tax liabilities).
If you are interested in learning more about whether Section 530 might be applicable in a situation to protect you from potentially catastrophic, retroactive assessments of Federal employment tax liabilities, or are interested in obtaining a formal legal opinion, in support of a worker classification issue, please contact us.
Strict Silo Tax Strategies & Potential SUTA Dumping Violations
As the IRS has focused more and more on the collection of revenue, and yet, businesses and taxpayers fall behind with payroll tax liabilities, there are promoters and the like who may believe it is appropriate to advise taxpayers as to how to avoid or evade payment of these liabilities. Under the Federal law, persons with authority to exercise significant control over the financial affairs of a company have a statutory duty to collect, withhold, truthfully account for, and pay over payroll “trust fund” taxes and that failure to intervene to stop and/or mitigate the nonpayment of collected payroll “trust fund” taxes can result in significant liability, even criminal liability. See, e.g., In re Mirabilis Ventures, Inc., Case No. 6:08-bk-04327-KSJ (Bank.M.D.Fla. 2008)(debtor brings forth malpractice claims against various professionals for making what they contend were misleading representations or for pursuing planning pursuant to a strict silo theory of tax liability that exposed the company and its principals to potential criminal liability).
Some of the tax strategies employed by promoters may be catching the attention of law enforcement officials. One possible example of this may be a tax strategy aimed at segregating tax liabilities, through a careful structuring of various affiliated or aligned companies, based on a strict silo theory of tax liability. Under this strategy, it is alleged that any payroll tax liabilities otherwise incurred by a subsidiary will remain with that subsidiary and such liability will not attach to the detriment of the parent company or affiliated subsidiaries. See, e.g., In re Mirabilis Ventures, Inc., Case No. 6:08-bk-04327-KSJ (Bank.M.D.Fla. 2008)(malpractice claims filed by debtor).
Many states have enacted legislation aimed at thwarting SUTA dumping, where new companies are formed, and old companies ditched, to take advantage of new experience ratings for workers compensation and the like.
If you have any questions or concerns about payroll tax liabilities impacting your company, or any tax strategies or advice you have been given with regard to the same, please do not hesitate to contact us.
Worker Classification Disputes with the IRS (Audit and Litigation)
Mr. Tufts has over 15 years of experience dealing with worker classification issues and has litigated these issues in both Federal court and advised with regard to determinations that ended up in the United States Tax Court. The Tufts Law Firm is of the view that the particular facts and circumstances of each case must be carefully analyzed, if a prudent litigation strategy is to be implemented. Clearly, it is prudent to make a proper worker classification determination early on, and carefully evaluate the pros and cons of contesting a proposed worker classification determination made by the IRS, either on appeal or in the courts.
If you need our assistance in dealing with the IRS in a worker classification determination or want to learn more about whether or not you or your company is eligible for Section 530 protection, please contact us.