4.23.5  Technical Guidelines for Employment Tax Issues

Manual Transmittal

December 10, 2013

Purpose

(1) This transmits a revision to IRM 4.23.5, Employment Tax, Technical Guidelines for Employment Tax Issues.

Background

Updates are made to this section for editorial, procedural, and technical changes.

Material Changes

(1) Editorial and technical changes have been made throughout this section.

(2) IRM 4.23.5.2.1(4). Deleted and incorporated into Effect of Section 530 on Workers.

(3) IRM 4.23.5.2.2(5). Deleted provisions relating to workers and Form SS-8 included elsewhere.

(4) IRM 4.23.5.2.2.3(1). Removed the wording with regard to liberal construction and clarified reasonable basis requirement.

(5) IRM 4.23.5.2.2.4(1). Deleted last sentence to align with IRS position.

(6) IRM 4.23.5.2.2.5(1). Revised to more closely track the language of section 530.

(7) IRM 4.23.5.2.2.5(4). Deleted last sentence, as there are not consolidated employment tax returns.

(8) IRM 4.23.5.2.2.5(6). Deleted as it repeats information in first paragraph of the section.

(9) IRM 4.23.5.2.2.6(1). Restated first sentence to clarify industry practice qualifications.

(10) IRM 4.23.5.2.2.7(4). Deleted text as confusing and provided succinct statement.

(11) IRM 4.23.5.2.3. Title changed to Effect of Section 530 on Workers. Entire section rewritten.

(12) IRM 4.23.5.2.3.1. Title changed to State and Local Employees. Deleted duplicative section 530 items to solely address state and local employees.

(13) IRM 4.23.5.2.3.2(2). Removed the sentence on incorporation and clarified.

(14) IRM 4.23.5.3(2). Edited and clarified.

(15) IRM 4.23.5.6.1(1). Removed reference to 20 common law factors.

(16) IRM 4.23.5.6.2(2). Deleted as repetitive.

(17) IRM 4.23.5.6.8. Edited to remove dated references.

(18) IRM 4.23.5.7.3. Clarification adding political subdivision and agency.

(19) IRM 4.23.5.9(3). Changed $400 to $108.28 and added references to IRM 1402(j)(2)(B) and Form 8274.

(20) IRM 4.23.5.10. New section, FICA Tax on Wages Paid to Residents of the Philippines for Services Performed in the Commonwealth of Northern Mariana Islands (CNMI). IGM SBSE-04-1212-107 incorporated into IRM providing guidance to examiners for this issue.

(21) IRM 4.23.5.11 and subsections. Formerly 4.23.5.10.

(22) IRM 4.23.5.12 and subsections. Formerly 4.23.5.11.

(23) IRM 4.23.5.13 and subsections. Formerly 4.23.5.12.

(24) IRM 4.23.5.14 and subsections. Formerly 4.23.5.13.

(25) IRM 4.23.5.15 and subsections. Formerly 4.23.5.14.

(26) IRM 4.23.5.16 and subsections. Formerly 4.23.5.15.

(27) Exhibit 4.23.5-2. Deleted last row on Section 530 Employee as technically inaccurate. Added code sections for each type of worker.

(28) Exhibit 4.23.5-4. Three cases deleted and additional cases added.

Effect on Other Documents

This material supersedes IRM 4.23.5, dated August 31, 2012. Interim Guidance Memorandum SBSE-04-1212-107, Interim Guidance on Enforcement of FICA tax on wages paid to residents of the Philippines for services performed in the Commonwealth of Northern Mariana Islands (CNMI), issued December 17, 2012, incorporated into this revision.

Audience

This section contains instructions and guidelines for all LB&I, TE/GE, and SB/SE employees dealing with employment tax issues.

Effective Date

(12-10-2013)

John H. Imhoff, Jr.
Director, Specialty Programs
Small Business/ Self-Employed Division

4.23.5.1  (08-31-2012)
Overview

  1. This section details the technical guidelines for Employment Tax Issues.

  2. The Internal Revenue Service administers the employment taxes imposed by Chapters 21 through 25 of the Internal Revenue Code and the self-employment taxes imposed by Chapter 2. An important phase of administration of employment taxes, including the self-employment tax, is interpreting the sections of the Code applicable to these taxes, that is, issuing rulings and technical advice that clarify the intent of these sections. The Service refers questions relating to:

    1. Eligibility for and computation of social security benefits ▸ to the Social Security Administration, Baltimore, Maryland, or to their nearest local field office.

    2. Unemployment benefits ▸ to the appropriate State Unemployment Compensation Board.

    3. Railroad employee retirement benefits ▸ to the Railroad Retirement Board, Chicago, Illinois.

  3. In carrying out these duties, the Service shares with these agencies a joint responsibility for administering the tax aspects of these programs. This requires close coordination between the IRS and these agencies at the national level to assure uniform interpretation and application of the various provisions of the law.

  4. Revenue Agents, Revenue Officer Examiners, Tax Compliance Officers, Tax Specialists, Indian Tribal Government Specialists, and Federal, State and Local Government Specialists, make determinations for FICA tax liability. Three conditions must be present for FICA tax liability:

    1. The relationship of employer-employee must exist.

    2. The remuneration paid by the employer must constitute "wages" for purposes of the tax.

    3. The employee must perform services that constitute "employment" as defined in IRC 3121(b).

4.23.5.2  (08-31-2012)
Section 530 of the Revenue Act of 1978

  1. Section 530 of the Revenue Act provides employers with relief from federal employment tax obligations if certain requirements are met. It terminates the employer's, not the worker’s, employment tax liability under Internal Revenue Code Subtitle C:

    • Chapter 21, Federal Insurance Contributions Act (FICA),

    • Chapter 22, Railroad Retirement Tax Act taxes (RRTA),

    • Chapter 23, Federal Unemployment Tax Act (FUTA),

    • Chapter 24, Federal income tax withholding (FITW), and

    • Chapter 25, General Provisions relating to employment taxes and collection of income taxes at source.

    and any interest or penalties attributable to the liability for employment taxes. See Rev. Proc. 85-18,1985–1 C.B. 518.

  2. Section 530(d) denies relief for certain technically skilled workers who provide services under a three-party situation.

  3. Section 530(e) clarifies that the first step in any case involving whether a taxpayer has employment tax obligations of an employer with respect to workers is determining whether the taxpayer meets the requirements of section 530. If so, the taxpayer will not have an employment tax liability with respect to the workers at issue.

  4. Section 530 relief can apply with respect to any employees defined in IRC 3121(d), IRC 3306(i), and IRC 3401(c). See section 3.09 of Rev. Proc. 85–18.

4.23.5.2.1  (12-10-2013)
Section 530 Relief

  1. Section 530 is a relief provision that must be considered as the first step in any case involving worker classification. Relief is available to taxpayers that are under examination or involved in administrative (including Appeals) or judicial proceedings with respect to assessments or proposed assessments based on employment status reclassification.

  2. The taxpayer need not concede or agree to the determination that the workers are employees for section 530 relief to be available.

  3. The examiner must first explore the applicability of section 530 even if the taxpayer does not raise the issue. It is not necessary for the taxpayer to claim section 530 relief for it to be applicable.

  4. Publication 1976, Do You Qualify for Relief under Section 530?, must be provided to the taxpayer before initiating any worker classification examination.

    1. This publication can be provided with the appointment letter or during the initial interview of an employment tax examination if a worker classification issue is identified during pre-exam or if worker classification is the reason for the examination.

    2. If an employment status issue arises during the course of an income tax or tax-exempt examination, the publication must be provided at that time.

    3. Notate how and to whom the publication was delivered in Form 9984, Examining Officer's Activity Record, in the case file.

4.23.5.2.2  (12-10-2013)
Establishing Section 530 Relief

  1. The taxpayer must meet two consistency requirements before the relief provisions of section 530 apply. The relief applies only if:

    1. All federal tax returns, including information returns such as Form 1099-MISC required to be filed with respect to the worker for the period, are timely filed and are filed on a basis consistent with the taxpayer’s treatment of the worker as not being an employee. See discussion at IRM 4.23.5.2.2.1, Consistency Requirement—Reporting Consistency, and

    2. The treatment of the worker as not being an employee is consistent with the treatment by the taxpayer (or predecessor) of all workers holding substantially similar positions. See discussion at IRM 4.23.5.2.2.2, Consistency Requirement—Substantive Consistency.

  2. In addition to the consistency requirements, the taxpayer must have had a reasonable basis for not treating the worker as an employee. See discussion at IRM 4.23.5.2.2.3, Section 530 - Reasonable Basis, and following.

  3. The examiner should work with the taxpayer to determine what information is needed to decide whether the taxpayer has met the requirements for section 530 relief. Exercise caution to ensure requested information is both relevant and reasonable.

  4. If the taxpayer establishes a prima facie case that it meets the reporting consistency requirement, the substantive consistency requirement, and one of the reasonable basis safe havens, and the taxpayer has fully cooperated with reasonable requests from the examiner, the Service will bear the burden of proving that the taxpayer’s treatment is inaccurate. Under section 530(e)(4), the burden of proof only shifts to the Service if the taxpayer establishes a prima facie case under one of the three safe haven provisions. The burden of proof does not shift if the taxpayer relied on some other reasonable basis. "Prima facie" means "at first sight" or "on the face of it." A prima facie case means that the taxpayer has presented evidence that will allow the taxpayer to prevail unless the government presents other evidence that contradicts and overcomes the taxpayer’s evidence.

  5. If the examiner determines that the taxpayer is entitled to relief under section 530, the issue of worker classification will be discontinued. The taxpayer should continue to file the required federal tax returns (such as Form 1099-MISC) with respect to the workers.

  6. Comments on Form 4318-ET, Employment Tax Examination Workpapers, SAIN lead sheet, Section 530 Lead Sheet Worker Classification Issues, or Form 5773,EP/EO Workpaper Summary Continuation Sheet, should explain the basis for allowing or denying the relief. In unagreed cases, address the section 530 relief issue in the Employment Tax Examiner's Report (ETER) in the same manner as any other unagreed issue (issues, statement of facts, law, taxpayer position, and conclusion). See IRM 4.23.10.17.1, Preparing Explanation of Adjustments.

4.23.5.2.2.1  (08-31-2012)
Consistency Requirement—Reporting Consistency

  1. The first requirement a taxpayer must meet to obtain relief under section 530 is timely filing of all required federal tax returns, including information returns such as Form 1099-MISC, with respect to the worker for the period, on a basis consistent with the treatment of the worker by the taxpayer as not being an employee. This provision applies on a period by period basis. That is, if a taxpayer in one year fails to file all required returns but in a subsequent year files all required returns on a basis consistent with the treatment of the worker as not being an employee, then the taxpayer may qualify for section 530 relief for the subsequent period. See Rev. Rul. 81-224; General Investment Corp. v. United States, 823 F.2d 337 (9th Cir. 1987); Rev. Proc. 85-18, sections 3.02, 3.03, 3.04.

  2. If a taxpayer is not required to file, relief will not be denied on the basis that the return was not filed. Rev. Rul. 81-224, 1981-2 C.B. 197, addresses specific questions about timely filing of Forms 1099–MISC. It provides that:

    1. Taxpayers that do not file timely all federal tax returns, including information returns such as Form 1099–MISC, consistent with their treatment of the worker as not being an employee may not obtain relief under the provisions of section 530 for that worker for that period.

    2. Taxpayers that mistakenly, in good faith, file the wrong type of Form 1099 do not lose section 530 eligibility.

  3. The best sources for determining whether Forms 1099–MISC were filed timely are Corporate Files On-Line (CFOL) or Integrated Data Retrieval System (IDRS). Campuses maintain information on the Payer Master File which records the taxpayer’s history of filing information returns. These transcripts can be requested internally using Command Code PMFOL.

4.23.5.2.2.2  (08-31-2012)
Consistency Requirement—Substantive Consistency

  1. The taxpayer (or a predecessor) must not have treated the worker, or any worker holding a substantially similar position, as an employee for any period after 1977. Rev. Proc. 85-18, section 3.03, provides guidelines for determining whether a taxpayer treated an individual as an employee for a period.

  2. The determination of whether workers hold substantially similar positions requires consideration of the relationship between the taxpayer and those individuals. This includes the degree of supervision and control. Differences in managerial responsibilities and differences in reporting requirements should be taken into account, along with differences in job duties, the contractual relationship, and the provision of employee benefits.

  3. The determination of what is substantially similar work rests on analysis of the facts. The day-to-day services that workers perform and the method by which they perform those services are relevant in determining whether workers, treated as independent contractors, hold substantially similar positions to workers treated as employees.

4.23.5.2.2.3  (12-10-2013)
Section 530 — Reasonable Basis

  1. In addition to the consistency requirements, the taxpayer must have had a reasonable basis for not treating the worker as an employee. It is the intent of Congress that the reasonable basis requirement should be construed liberally in favor of the taxpayer.

  2. A taxpayer will be treated as having a reasonable basis for not treating a worker as an employee if the treatment was in reasonable reliance on one of three safe havens:

    1. Judicial precedent, published rulings, technical advice with respect to the taxpayer, or a letter ruling to the taxpayer. See IRM 4.23.5.2.2.4.

    2. A past Internal Revenue Service audit of the taxpayer in which there was no assessment attributable to the treatment (for employment tax purposes) of the individuals holding positions substantially similar to the position held by this individual. See IRM 4.23.5.2.2.5.

    3. A long-standing recognized practice of a significant segment of the industry in which the taxpayer was engaged. See IRM 4.23.5.2.2.6.

  3. To satisfy one of the safe havens, a taxpayer must demonstrate that it actually and reasonably relied on the safe haven in treating the workers as nonemployees for the period at issue. The taxpayer must have relied on the asserted reasonable basis during the periods in issue, at the time the employment decisions were being made. See Nu-Look Design, Inc. v. Commissioner, T.C. Memo. 2003-52, aff’d., 356 F.3d 290 (3d Cir. 2004).

  4. A taxpayer that fails to meet any of the three "safe havens" may nevertheless be entitled to relief if the taxpayer can demonstrate, in some other manner, any reasonable basis for not treating the worker as an employee. See IRM 4.23.5.2.2.7, Other Reasonable Basis.

4.23.5.2.2.4  (12-10-2013)
Safe Haven—Judicial Precedent or Published Rulings

  1. To qualify for the judicial precedent safe haven, a taxpayer must have reasonably relied on a particular judicial precedent or published ruling or on technical advice relating to the taxpayer or a letter ruling to the taxpayer. For judicial precedent or a published ruling, the facts must be similar to the situation of the taxpayer.

  2. The taxpayer must have relied on the judicial precedent or published ruling during the periods in issue, at the time the employment decisions were being made. The reliance does not necessarily have to have taken place when the taxpayer first engaged the workers, but it must have been before the tax period at issue. See Nu-Look Design, Inc. v. Commissioner, T.C. Memo. 2003-52, aff’d., 356 F.3d 290 (3d Cir. 2004) and Peno Trucking, Inc. v. Commissioner, T.C. Memo. 2007-66, rev’d in unpublished opinion, 296 Fed.Appx. 449, 2008 WL 4463765. (6th Cir. 2008).

  3. State court decisions and rulings of agencies other than IRS do not constitute judicial precedent. Under some circumstances, however, state court decisions and federal agency rulings may be the basis for findings that the taxpayer reasonably relied on some other reasonable basis. This distinction, that state court decisions may qualify as other reasonable basis rather than judicial precedent, is important because the burden of proof may shift to the IRS if the taxpayer establishes a prima facie case for "judicial precedent" but not for "other reasonable basis." See IRM 4.23.5.2.2(4).

4.23.5.2.2.5  (12-10-2013)
Safe Haven—Prior Audit

  1. To qualify for the prior audit safe haven, a taxpayer must show that it reasonably relied on a prior IRS audit of the taxpayer in which there was no assessment attributable to the taxpayer’s treatment, for employment tax purposes, of individuals holding positions substantially similar to the position held by the individual whose treatment is at issue. 530(a)(2)(B). For examinations that began after December 31, 1996, the IRS audit must have included an examination for employment tax purposes of the status of the individual involved or any individual holding a position substantially similar to the position held by the individual involved.

  2. A taxpayer does not meet this test if, in the conduct of a prior examination, an assessment attributable to the taxpayer’s treatment of the worker was offset by other claims asserted by the taxpayer. Nor can the taxpayer rely on a prior audit if the current working relationship between the taxpayer and the workers is significantly different from their working relationship at the time of the audit.

  3. The audit must have included an examination of the taxpayer’s books and records.

    1. Inquiry or correspondence from a Campus or an SS-8 unit is not treated as a past examination.

    2. Applications for status determination, such as an application for recognition for exemption from income tax as an exempt organization or an application for a determination letter for an employee benefit plan made on Form 5300 or Form 5309, do not constitute an examination.

    3. An examination of an employee benefit plan or consideration of Form 5500,Annual Return/Report of Employee Benefit Plan, generally does not constitute an examination because the plan is not the taxpayer that employs the workers. However, an examination of the taxpayer’s pension plan that leads to an examination of the taxpayer’s books (i.e., such as payroll records to determine whether coverage requirements have been met) may create a safe haven for the taxpayer.

  4. The prior examination safe haven is limited to past examinations conducted on the taxpayer itself. Therefore, a taxpayer is not entitled to relief based upon a prior examination of any of its workers. Nor would a subsidiary corporation usually be entitled to relief based upon a prior examination of its separately filing parent corporation.

  5. If a taxpayer which was previously examined begins conducting a new line of business, that taxpayer is not entitled to relief based upon the examination of the original line of business. However, if there has only been a change of form and the successor entity is in the same line of business, the taxpayer could qualify for section 530 relief based on other reasonable basis.

4.23.5.2.2.6  (12-10-2013)
Safe Haven—Industry Practice

  1. To qualify for the industry practice safe haven, the taxpayer must show that it reasonably relied on a long-standing recognized practice of a significant segment of its industry. An industry generally consists of businesses located in the same geographic or metropolitan area which provide the same product or service and compete for the same customers.

  2. Section 530(e)(2)(B) clarifies that 25 percent of the taxpayer’s industry (determined without taking the taxpayer into account) is deemed to constitute a significant segment of the industry. The legislative history notes that a lower percentage may be a significant segment, depending on the facts and circumstances.

  3. Section 530(e)(2)(C) provides that practices that have existed for more than 10 years are long-standing. The legislative history notes that the 10-year rule is merely a safe haven. A shorter period may be long-standing, depending on the facts and circumstances.

  4. A claim of reliance on industry practice necessarily requires that the business knew of the industry practice at the time the employment decisions were being made for the periods in issue. The long-standing industry practice must have existed at that time in order to be relied upon.

  5. Whether the taxpayer relied on industry practice can generally be established by several types of evidence. Examine taxpayer records, such as corporate minutes or unanimous consents in lieu of director’s meetings, to determine whether any written record exists that shows the reason for treatment of workers as independent contractors. Interview the workers themselves to determine what reasons were given to them by the taxpayer when establishing their status as independent contractors.

4.23.5.2.2.7  (12-10-2013)
Other Reasonable Basis

  1. A taxpayer that fails to meet any of the three "safe havens" may still be entitled to relief if it can demonstrate that it relied on some other reasonable basis for not treating a worker as an employee. The legislative history indicates that reasonable basis should be construed liberally in favor of the taxpayer. H.R. Rep. No. 95-1748 (1978).

  2. Reliance on an attorney or accountant may constitute a reasonable basis. The taxpayer need not independently investigate the credentials of the attorney or accountant to determine whether such advisor has any specialized experience in the employment tax area. However, the taxpayer should establish at a minimum, that it reasonably believed the attorney or accountant to be familiar with taxpayer's tax issues and that the advice was based on sufficient relevant facts furnished by the taxpayer to the adviser. If other evidence shows that the adviser clearly was not qualified, the mere holding of a law or accounting license would not make the reliance on the advice of the attorney or accountant reasonable. Advice could not have been relied upon unless it had been furnished at the time the employment decisions were being made for the periods in issue. See In re Compass Marine Corporation, 146 B.R. 138 (Bkrpcy E.D. Pa. 1992). In that case, it was held that advice from its labor counsel issued three years after the treatment does not support the treatment.

  3. Prior state administrative action (e.g., workers’ compensation decisions) and other federal determinations (e.g., determinations under the Federal Labor Standards Act (Wage and Hour Division)) may or may not constitute a reasonable basis. This will depend on whether they use the same common law rules that apply for federal employment tax purposes. If the state or federal agency uses the same common law standard and interprets it similarly, its determination may constitute a reasonable basis. If the state or federal agency uses a different statutory standard or interprets the common law standard differently, its determinations should not constitute other reasonable basis.

  4. A PLR or TAM issued to the taxpayer’s predecessor does not qualify as judicial precedent.

4.23.5.2.3  (12-10-2013)
Effect of Section 530 on Workers

  1. Generally, a worker status determination is not made when an examiner grants section 530 relief to the taxpayer. However, workers may be determined to be employees through some other means such as an employee plans examination. In addition, workers may request a determination of their individual status by filing a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. See IRM 4.23.2.6, SS-8 Program, for additional information.

  2. It is important to remember that even if an employer is entitled to relief under section 530, workers determined to be employees in paragraph (1) are employees for other purposes of the Code. Section 530 only terminates the liability of the employer for the employment taxes but has no effect on the employees’ status. It does not convert workers from the status of employee to the status of self-employed (independent contractor). The workers are still considered employees for income tax and qualified benefit plan eligibility purposes. Therefore, the employer must consider these workers as employees in determining whether its pension, profit-sharing, or stock-bonus plan satisfies the qualification requirements of IRC 401(a).

  3. The workers determined to be employees in paragraph (1) remain liable for the employee share of FICA tax with respect to all wages received. See Rev. Proc. 85-18, section 3.08, and Treas. Regs. 31.3102-1(c). See also Rev. Rul. 86- 111, 1986-2 C.B. 176

  4. ) Where workers determined to be employees in paragraph (1) have filed and paid their tax under the Self Employment Tax Contributions Act (SECA), they may file a claim for refund for the difference between SECA tax and the employee share of FICA, if applicable. However, they may owe additional tax if the employee share of FICA exceeds the SECA that they actually paid. The specific tax effect will depend on a number of factors, including the amount of expenses deducted on Schedule C (if any) and whether the expenses are allowable as a deduction on Schedule A as employee business expenses.

  5. As an employee, the worker generally cannot deduct unreimbursed business expenses on Schedule C but must deduct them as miscellaneous itemized deductions on Schedule A of Form 1040, subject to the two percent limitation of citation IRC 67. This sometimes results in liability for the alternative minimum tax. Further, the worker cannot adopt or maintain a self-employment retirement plan. Finally, certain benefits provided by the taxpayer to a worker as an employee may be excludable from income by the employee due to specific IRC exclusions provided only to employees (e.g., employer provided accident and health insurance).

  6. Notice 989, Commonly Asked Questions When IRS Determines Your Work Status is "Employee" , is mailed to the taxpayer who submit a Form SS-8 to determine their exact employment tax status (i.e., employee or independent contractor), along with the appropriate SS-8 Determination Program Letter. It contains information for Form 1040 filers if their status is changed to employee.

4.23.5.2.3.1  (12-10-2013)
State and Local Employees

  1. Workers covered under a Section 218 Agreement are employees for purposes of FICA without application of the common law rules. See IRC 3121(d)(4). This classification is not made under rules found in the IRC or the regulations thereunder. The classification is made by the Social Security Act. For these workers, section 530 relief for FICA taxes is unavailable.

  2. There is no provision in Chapter 24, Collection of Income Tax at Source, similar to IRC 3121(d)(4), which provides that workers covered under a Section 218 Agreement are employees. The IRS has jurisdiction over the determination of whether state and local workers are employees for federal income tax withholding purposes. Section 530 relief is available, retroactively, for income tax liability if the requirements of section 530 are met. The taxpayer would be required to withhold income tax prospectively.

  3. The common law rules are used to determine the status of a state or local government worker who is not covered under a Section 218 agreement. Relief under section 530 is available for these workers, if the requirements for section 530 relief are satisfied.

4.23.5.2.3.2  (12-10-2013)
Workers Not Covered by Section 530

  1. Section 530(d) provides that relief under section 530(a) is not available in the case of a worker who, pursuant to an arrangement between the taxpayer and a client, provides services for that client as any of the following:

    • Engineer

    • Designer

    • Drafter

    • Computer programmer

    • Systems analyst

    • Other similarly skilled worker engaged in a similar line of work.

  2. Section 530(d) applies only to the taxpayer in a three-party situation, namely, the taxpayer providing workers to a client. The intent of Congress was to classify, under the common law rules, workers retained by taxpayers to provide technical services without regard to section 530 of the Revenue Act of 1978. Section 530(d) does not change anyone from an independent contractor to an employee. The examiner must still look at the common law rules.

4.23.5.3  (12-10-2013)
Independent Contractor or Employee

  1. For Federal tax purposes, there are two classifications of workers: a worker is either an employee or an independent contractor. This is an important issue and has the potential to change the tax responsibilities of both the taxpayer and the workers.

  2. Either worker classification — independent contractor or employee — can be a valid and appropriate business choice.

4.23.5.4  (02-01-2003)
Developing the Facts

  1. Worker status cannot be determined simply by looking at job titles. Facts must be developed to make a correct determination. When developing the facts, consider the following:

    1. In making a determination, look at the entire relationship between a taxpayer and a worker. The relationship often has several facets, some indicating the taxpayer has control, while others indicate it does not.

    2. Control is a matter of degree. In fact, even in the clearest case of an independent contractor, the worker is constrained in some way. Conversely, employees may have autonomy in some areas.

  2. It is important to first understand the work that is being performed and the business context in which it is being performed. The examiners need to identify and evaluate evidence. This is a critical point in case development. The types of evidence that help to determine control in the common law employer-employee relationship are listed in Exhibit 4.23.5-1.

  3. To make a correct determination regarding the status of the worker, examiners need to consider the evidence of both autonomy and the right to control.

  4. In determining whether a worker is an employee, first apply the common law rules.

    1. If the facts do not support a position that a worker is a common law employee, then apply the rules under IRC 3121(d)(3) to determine if the worker is a statutory employee. See Exhibit 4.23.5-3.

    2. If a statutory employee relationship exists, the employer and employee are liable for their respective shares of FICA. Employers of statutory employees described in IRC 3121(d)(3)(A) (agent drivers) and IRC 3121(d)(3)(D) (traveling or city salespersons) are also liable for FUTA. Statutory employees are not subject to income tax withholding.

  5. When an employer-employee relationship exists, it is of no consequence whether the employee is designated as a trustee, agent, independent contractor, or other title. Additionally, signing a contract does not always indicate the worker is self-employed. What does govern is the substance of a particular relationship, and consequently taxpayers cannot contract away their employment tax liabilities. See Exhibit 4.23.5-4, Employer-Employee Relationship Cases, for assistance.

4.23.5.5  (02-01-2003)
Categories of Employees

  1. IRC 3121(d) contains four separate and independent categories of employee. A worker is an employee if he or she is one of the following:

    • Common law employee,

    • Corporate officer,

    • Certain statutory employee, or

    • Employee covered by an agreement under Section 218 of the Social Security Act.


    See Exhibit 4.23.5-4, Employment Tax Treatment for Various Categories of Workers

4.23.5.6  (02-01-2003)
Common Law Standard

  1. The common law rules for determining whether a worker is an employee or an independent contractor are described in Treas. Regs. 31.3121(d)–1(c). Under common law, a worker is an employee when the person for whom the services are performed has the right to control and direct the individual who performs the services. This control reaches not only the result to be accomplished, but also the details and means by which that result is to be accomplished. Note that control must be present, but need not actually be exercised. Also, note that courts have held that the degree of supervision necessary to demonstrate control is only "such supervision as the nature of the work requires." McGuire v. United States, 349 F. 2d 644, 646 (1965 9th Cir.).

4.23.5.6.1  (12-10-2013)
Control Test

  1. To determine whether the control test is satisfied in a particular case, the facts and circumstances must be examined. Ask questions about the relationship between the worker and the taxpayer to ascertain control.

  2. The twenty factors listed in Rev. Rul. 87-41 may still be used for reference purposes, but the primary method is to consider every piece of information in a case that helps to decide the extent to which the taxpayer does or does not retain the right to control the worker. The evidence tends to fall into three main categories:

    1. Behavioral control,

    2. Financial control, and

    3. Relationship of the parties.


    See Exhibit 4.23.5-1, Determining the Right to Direct or Control.

  3. There are four important points to remember:

    1. There is no "magic number" of relevant evidentiary factors.

    2. Whatever the number of factors used, the factors merely point to facts to be used in evaluating the extent of the right to direct and control.

    3. As in any examination, all relevant information needs to be explored before answering the legal question of whether the right to direct and control associated with an employment relationship exists.

    4. The evidence the examiner gathers must be factual and well-documented. It must support the examiner's determination.

  4. The pieces of information that are important to help determine employee status change over time because business relationships change over time. What might have been a crucial piece of evidence in 1985 on which to base a decision about whether a taxpayer retained the right to control a worker may not carry the same weight for making an employee status determination currently.

  5. For example, the fact that a delivery driver was required to wear a uniform bearing the name of the retail business demonstrated control indicative of an employee relationship. Today, these requirements may be established to provide customers with some assurance that the worker can be safely allowed entry to the home or business. In other words, the wearing of the uniform today may have less to do with the degree of control exercised by the taxpayer over the worker than it had in the past.

4.23.5.6.2  (12-10-2013)
Common Law Employees

  1. For FICA, FUTA, and income tax withholding, the term "employee" includes any individual who, under the usual common law rules for determining the employer/employee relationship, has the status of an employee. Therefore, with certain exceptions, the imposition of employment taxes always involves the employer/employee relationship issue and requires the application of the common law rules to the specific facts and circumstances of each taxpayer. This application is the basis for determining the employment status of an individual worker or a group of workers.

  2. In a case requiring an employer-employee relationship determination, the examiner will compile information bearing on the factors explained. Evaluating such evidence will generally enable the examiner to resolve the employer-employee relationship question by applying law, regulations or a clearly applicable ruling.

  3. For treatment of special types of employment and special types of wage payments, refer to Publication 15, (Circular E) Employer's Tax Guide, for quick research on an issue. The Code, regulations, revenue rulings, court decisions, and any other pertinent research are the best authority for any issues being proposed. Also, refer to the Exhibit section for a quick reference regarding the tax treatment by the employer of FICA, FUTA, and income tax withholding of wages earned by the various types of workers. See Exhibit 4.23.5-2, Employment Tax Treatment for Various Categories of Workers.

  4. If the relationship of employer-employee exists, the designation or description of the parties as anything other than that of employer-employee is immaterial. Contractual designation of a worker as an independent contractor cannot outweigh evidence regarding the actual relationship between worker and taxpayer. Questions arising in employer-employee relationships which cannot be resolved by the examiner should be referred to the Headquarters Office for technical advice in accordance with IRM 4.23.15, Employment Tax - Technical Advice From the Office of Chief Counsel.

4.23.5.6.3  (08-31-2012)
Corporate Officers

  1. Corporate officers are specifically included within the definition of an employee under FICA, FUTA, and federal income tax withholding purposes. See IRC 3121(d)(1), IRC 3306(i), and IRC 3401(c). The common law standard is not applicable. The regulations provide that generally an officer of a corporation is an employee of the corporation. However, the regulations provide a narrow exception - an officer is not considered to be an employee of the corporation if two requirements are met:

    1. The officer does not perform any services or performs only minor services, and

    2. The officer is not entitled to receive, directly or indirectly, any remuneration.

    See Treas. Regs. 31.3121(d)-1(b).

  2. The officer must meet both requirements to be excepted from employee status. In determining whether services performed by a corporate officer are considered minor or nominal, examine the character of the service, the frequency and duration of performance, and the actual or potential importance or necessity of the services in relation to the conduct of the corporation’s business. See Rev. Rul. 74–390, 1974–2 C.B. 331.

  3. A director of a corporation, acting in the capacity of a director, is not an employee of the corporation for those services, even if that worker also serves as an employee or officer of the corporation for other services. Therefore, part of the compensation paid to this worker can be for services rendered as an independent contractor (director) and part of the payments can be for services rendered as an employee. See Rev. Rul. 58–505, 1958–2 C.B. 728.

  4. Examine all payments to the officer, such as amounts labeled as draws, loans, dividends, or other distributions to determine whether the payments are potentially wages for FICA, FUTA, and income tax withholding purposes. See Rev. Rul. 74–44, 1974–1 C.B. 287.

  5. Examiners must address section 530 in all officer worker classification cases. Section 530 must be considered when there is a controversy involving whether individuals are employees. If a corporation treats an officer as an independent contractor and files Form 1099-MISC , the reporting consistency requirement of section 530(a)(1)(B) is met. Likewise, if the corporation pays distributions and provides Schedule K-1 consistent with this treatment, then the reporting consistency requirement is met. Generally, the taxpayer will have difficulty satisfying the reasonable basis requirement of section 530 since officers who perform services for the corporation are employees by statute under IRC 3401(c), IRC 3121(d)(1), and IRC 3306(i).

  6. In any officer worker classification compensation case where the corporation does not treat the officer’s compensation as wages (does not file Form W-2 for the officer), examiners should follow the provisions of IRC 7436 and, following normal appeal procedures, issue a Notice of Determination of Worker Classification (NDWC), if unagreed. For additional information see IRM 4.23.10.9, Special Procedures for Notices of Determination of Worker Classification or Section 530 Relief.

  7. For IRC 7436 to apply, the determination with respect to worker classification must involve an actual controversy. Where the taxpayer treated the individual as an employee, by filing Form W-2 for example, there is no controversy and the provisions of Section 7436 do not apply. However, where the taxpayer did not treat the individual as an employee, there is an actual controversy. This is the case even if the individual is a corporate officer and despite the fact that the IRC specifically defines an officer of a corporation as an employee for employment tax purposes. See IRC 3401(c), IRC 3121(d)(1), and IRC 3306(i).

  8. When a corporate officer performs services for a corporation and the corporation does not treat the officer’s compensation as wages, a controversy regarding whether the officer is an employee exists, whether the corporation treats the officer as an independent contractor, partner, lessee, or recipient of royalty, dividend, or loan payments. The officer may have received a Form 1099-MISC, Schedule K-1, or no information return at all.

  9. Officer worker classification compensation cases that involve whether certain payments are wages may be eligible for inclusion in the Classification Settlement Program (CSP). For additional information, and examples of the determination of reasonable compensation, see IRM 4.23.6.9, CSP and Officer Compensation Procedures.

4.23.5.6.4  (11-03-2009)
Statutory Employees

  1. If a worker is not an employee under the usual common law rules or a corporate officer, the worker and the taxpayer may nevertheless still be subject to employment taxes. IRC 3121(d)(3) lists individuals in four occupational groups who, under certain circumstances, are considered employees for FICA tax and, in some instances, employees for FUTA tax, but not for income tax withholding. These workers are referred to as statutory employees. They are:

    1. Agent-drivers or commission-drivers,

    2. Full-time life insurance salespersons,

    3. Home workers, and

    4. Traveling or city salespersons.

  2. Workers in these four occupational groups are employees for FICA tax purposes even though they do not meet the common law test, if they meet the general and specific requirements for each occupational group.

  3. To qualify as a statutory employee, a worker must first meet general requirements prescribed specifically for the category under which the worker is qualifying (Treas. Regs. 31.3121(d)–1(d)). Exhibit 4.23.5–3 contains the requirements that determine statutory employees under FICA. See Exhibit 4.23.5-3.

  4. By definition, a worker cannot be a statutory employee under IRC 3121(d)(3) if that worker is a common law employee. See Ewens and Miller, Inc. v Commissioner, 117 T.C. 263 (2001). This conclusion is supported by the legislative history of IRC 3121(d). See S. Rep. No. 1669, 81st Cong., 2d. Sess. 144 (1950), 1950–2 C.B. 302, 346 - 348, and Lickiss v. Commissioner, T. C. Memo 1994–103.

  5. Statutory employees are not employees for the purpose of deducting trade or business expenses. Therefore, they may deduct their expenses on Schedule C rather than as miscellaneous itemized deductions on Schedule A. They receive a Form W–2. A check is made in Box 13 in the "Statutory Employee Box" to indicate that the worker is a statutory employee. Income tax withholding is not withheld from statutory employees. See Rev. Rul. 90–93, 1990–2 C.B. 33.

  6. If statutory employees also have earnings from self-employment, they may not use expenses from services as a statutory employee to reduce net earnings from self-employment for SECA proposes. This is because services as a statutory employee do not constitute the carrying on of a trade or business for purposes of SECA. Statutory employees are required to file a Schedule C for services performed as a statutory employee which is separate from the Schedule C that reports net earnings from self-employment.

4.23.5.6.4.1  (02-01-2003)
Statutory Employee—Employee Benefits

  1. Except for full-time life insurance salespersons, statutory employees remain independent contractors for employee benefit purposes. Thus, they are not eligible to participate in the employee benefit plans sponsored by the taxpayer for employees and cannot enjoy the exclusions from income for amounts paid under accident and health insurance arrangements under IRC 104, IRC 105, and IRC 106 to the extent that those income tax exclusions apply only to employees. However, statutory employees can establish and maintain their own self-employed retirement plans.

  2. Full-time life insurance salespersons are an exception. They are treated as employees not only for FICA tax purposes, but also for certain employee benefit programs maintained by the taxpayer, see IRC 7701(a)(20). Thus, they may participate as employees under the taxpayer’s group term life insurance program under IRC 79, apply the exclusions available to employees participating in the taxpayer’s accident and health plans under IRC 104, IRC 105, and IRC 106, and participate as an employee in the taxpayer’s qualified deferred compensation or retirement plans under IRC 401(a) and the taxpayer’s cafeteria plan under IRC 125. On the other hand, a full-time life insurance salesperson may not base contributions to a self-employed retirement plan (commonly called a Keogh plan) on the compensation received from the insurance business.

4.23.5.6.5  (02-01-2003)
Statutory Non-Employees

  1. Workers in three occupations will not be treated as employees for FICA, FUTA, or federal income tax withholding purposes provided they meet certain qualifications. These workers are referred to as "statutory non-employees."

    1. IRC 3508(b)(1) provides that, for all IRC purposes, qualified real estate agents are statutory non-employees.

    2. IRC 3508(b)(2) provides that, for all IRC purposes, direct sellers are statutory non-employees.

    3. IRC 3506 provides that, for purposes of subtitle C of the Code relating to employment tax, qualifying companion sitters are statutory non-employees.

4.23.5.6.6  (02-01-2003)
Qualified Real Estate Agents

  1. IRC 3508(b)(1) provides that an individual is a qualified real estate agent if the following requirements are met:

    1. The worker is a licensed real estate agent.

    2. Substantially all of such worker’s remuneration for services is directly related to sales or other output rather than to the number of hours worked.

    3. A written contract exists between the worker and the taxpayer for which services are being performed that provides that the worker will not be treated as an employee for federal tax purposes.

  2. Proposed Treas. Reg. 31.3508–1(b)(2) defines services performed as a real estate agent and provides examples. Services performed as a real estate agent do not include management of property.

4.23.5.6.7  (11-03-2009)
Direct Sellers

  1. IRC 3508(b)(2) provides that a worker is a direct seller if the following qualifications are met:

    1. The worker is engaged in the sale of consumer products in the home or in other than a permanent retail establishment; engaged in delivering or distribution of newspapers; or engaged in sale of consumer products for resale in the home or in other than a permanent retail establishment.

    2. Substantially all of such worker’s remuneration for services is directly related to sales or other output rather than to the number of hours worked.

    3. A written contract exists between the worker and the taxpayer for which services are being performed that provides that the worker will not be treated as an employee for federal tax purposes.

4.23.5.6.8  (12-10-2013)
Newspaper Carriers and Distributors

  1. Qualifying newspaper distributors and carriers are direct sellers. A person engaged in the trade or business of the delivery or distribution of newspapers or shopping news qualifies as a direct seller provided all remuneration is directly related to sales or output, rather than hours worked. Also, the services must be performed pursuant to a written contract that provides the person will not be treated as an employee for federal tax purposes.

4.23.5.6.9  (02-01-2003)
Companion Sitters

  1. IRC 3506 provides that a companion sitter will not be an employee of a companion sitting placement service if the companion sitting placement service neither pays nor receives the salary or wages of the sitter. The placement service may be compensated on a fee basis by either the sitter or the individual for whom the sitting is performed. The companion sitter is deemed to be self-employed unless considered to be a statutory or common law employee of the individual for whom the services are performed.

4.23.5.7  (02-01-2003)
Government Entities

  1. The Federal, State and Local Governments office (FSLG) is responsible for education and compliance activities affecting government entities. Examination of these entities will not be initiated by other operating divisions without the express written approval of the FSLG Director.

  2. The Indian Tribal Governments office (ITG) has responsibility for employment tax and all other aspects of Federal tax administration as it applies to Indian and Alaskan Native tribal governments. See IRM 4.86.1, Indian Tribal Governments Administrative Guidance - Indian Tribal Governments Administration. All IRS employees are required to contact the local area ITG Specialist before making initial contact on Indian tribal government cases.

4.23.5.7.1  (02-01-2003)
State and Local Government Employees Coverage

  1. State and local government employees were excluded from social security coverage from 1935 (the date of the original Social Security Act) until 1950 because there was a legal question regarding the federal government's authority to tax state and local governments. Beginning in 1951, states were allowed to enter into voluntary agreements with the federal government to provide social security coverage to public employees. These agreements are called Section 218 Agreements because they are authorized by Section 218 of the Social Security Act. See IRC 3121(b)(7)(E).

    Note:

    Because of the voluntary nature of Section 218 Agreements, the extent of social security coverage varies from state to state.

4.23.5.7.2  (02-01-2003)
Section 218 Agreements

  1. State and local government employees can be covered for social security and Medicare purposes through an agreement between the state and the Social Security Administration (SSA).

  2. Each state's original Section 218 Agreement ("Agreement" ) incorporates the basic provisions, definitions, and conditions for coverage. Additional coverage is provided by modifications. Each modification, like the original Agreement, is binding upon all parties. The initiative for securing coverage lies with the state.

  3. Coverage under an Agreement must be provided for employees by groups. An Agreement may be modified to increase the extent of coverage but generally not to reduce the amount of coverage. (An exception applies to election worker services and solely fee–based positions.)

4.23.5.7.2.1  (11-03-2009)
Mandatory Social Security Coverage

  1. Effective July 2, 1991, social security and Medicare coverage is mandatory for state and local government employees who are not qualified participants in a public retirement system and who are not covered under a Section 218 Agreement. See IRC 3121(b)(7)(F).

  2. Employees hired or rehired after March 31, 1986, and currently covered under the Medicare portion of FICA remain subject to that tax regardless of their membership in a retirement system. Employees covered by social security under a Section 218 Agreement are automatically covered.

4.23.5.7.2.2  (11-03-2009)
Mandatory Medicare Coverage

  1. State and local government employees hired (or rehired) after March 31, 1986, are subject to mandatory Medicare coverage. Public employees covered under a Section 218 Agreement are already covered under Medicare. Employees whose services are not covered for social security but who are required to pay the Medicare-only portion of FICA are referred to as Medicare Qualified Government Employees (MQGE).

  2. Employees who have been in continuous employment with the employer since March 31, 1986, who are not covered under a Section 218 Agreement, nor subject to the mandatory social security and Medicare provisions, remain exempt from both social security and Medicare taxes, provided they are members of a public retirement system. (See Publication 963, Federal / State Reference Guide State / Local Government Employers, for additional guidance.)


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