Since enactment of Section 530 of the Revenue Act of 1978, the Treasury Department has been precluded from issuing guidance on how properly to classify workers. This may soon end if the Taxpayer Responsibility, Accountability, and Consistency Act (H.R. 5804) is enacted. It was introduced on April 15, 2008, by Democratic Representatives Jim McDermott, John Tiery, and Richard Neal, each of whom serves on the House Ways and Means Committee. H.R. 5804, among other things, would amend the Internal Revenue Code of 1986 (the “Code”) by adding a new Section 3511 containing rules regarding employers’ classification of individuals as independent contractors. Specifically, Section 3511 would limit the bases upon which an employer could reasonably rely in classifying an individual as an independent contractor. H.R. 5804 also would increase financial tax penalties for employers who misclassify workers as independent contractors without a reasonable basis.
Federal tax law requires employers to withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment taxes for employees, but not independent contractors. Under current law, Section 530 of the Revenue Act of 1978 provides a “safe harbor” for employers who misclassify a worker as an independent contractor. It prohibits the Internal Revenue Service (“IRS”) from collecting employment taxes from an employer who makes such a misclassification if it had a reasonable basis for doing so.
Section 530 provides that an employer has a reasonable basis for not treating an individual as an employee if it relied on “judicial precedent, published rulings, technical advice with respect to the taxpayer, or a letter ruling to the taxpayer; a past [IRS employment tax] audit of the [employer] in which there was no assessment attributable to the treatment…of the individuals holding positions substantially similar to the position held by this individual; or long-standing recognized practice of a significant segment of the industry in which such individual was engaged.”
H.R. 5804 would replace Section 530 with Section 3511, which would severely limit an employer’s means for establishing that it had a reasonable basis in determining an individual’s employment status. Section 3511 would provide that an employer will have a reasonable basis if it acted in reliance on a “written determination,” which the Code defines as a ruling, determination letter, technical advice memorandum, or Chief Counsel advice, issued to the employer regarding the individual’s (or another individual holding a substantially similar position) employment status. Alternatively, the employer would be permitted to rely on a “concluded examination” of an individual’s employment status for employment tax purposes, for which it was determined that the individual (or another individual holding a substantially similar position) is not an employee.
H.R. 5804 would shift the burden of proof. Under Section 530, the IRS has the burden of proving an employer misclassified a worker if the employer establishes a prima facie case that it was reasonable not to treat the individual as an employee and the employer fully cooperates with reasonable requests from the IRS. Section 3511 would require an employer to establish its entitlement to relief under Section 3511 by a preponderance of the evidence, thereby shifting the burden of proof to the employer.
H.R. 5804 also would enable individuals to petition the IRS to review the classification of their employment status and allow for an administrative appeal of a determination that an individual was not an employee. Further, it would prohibit employers from retaliating or discriminating against an individual with regard to his or her “compensation, terms, conditions, or privileges of the services provided by the individual” because he or she or any person on behalf of the individual filed a petition.
In addition, H.R. 5804 would require the Treasury Department to submit annual reports on worker classification to Congress. This includes: information on and examinations of the number and type of enforcement actions against employers misclassifying workers and the relief obtained; estimates of the number of employers misclassifying workers, the number of workers affected, and industries involved; the effect of misclassification on the Federal Tax system; and information regarding the outcome of employment status petitions filed.
H.R. 5804 is strongly backed by several union organizations, including the Teamsters and “Change to Win,” a partnership of seven other unions.