Section
530 of 1978 Revenue Act
Section 530 of the 1978 Revenue Act, colloquially known as "Safe
Haven" was created to provide some protection for businesses employing independent
contractors. Section 530 evolved through Congress in reaction to a campaign
in the 1970's launched by the IRS to reclassify independent contractors as employees.
Section 530 explicitly identified circumstances where a contractor could be
legitimately employed so that businesses could quickly and easily demonstrate
conformity with tax regulations and forestall a costly IRS audit. Safe Havens
created a legal framework within which re classifications could be contested.
Section 530 has given rise to controversy over the years as interpretation
of the law has been changed by the IRS. State tax authorities are not bound
by Section 530 and have overridden its provisions at their own discretion.
New challenges from the IRS may overturn some of the protection firms have
found. These challenges apply both to current and historical contracts. In
some instances audits have contested labor classifications occurring over
the last decade.
Interpretation of Section 530
A number of commentaries have appeared in the popular press suggesting that
this long-running difficulty has been resolved for the smaller business and
entrepreneur. Unfortunately, this is confusing and untrue.
The "Independent Contractor Tax Simplification Act" was not enacted. This
bill expired, and a new bill will now have to be introduced in the 105th Congress.
A procedural amendment to Section 530 of the Revenue Act of 1978 was enacted
under Section 1122 of the Small Business Job Protection Act of 1996 (H.R.
3448). Let's look at the impact of this amendment.
The Revenue Act of 1978 produced Section 530 to address the controversies
that were arising between the IRS and business taxpayers over whether businesses
had correctly classified certain workers as self employed, i.e., independent
contractors, rather than as employees. Section 530 "...generally allows a
taxpayer to treat a worker as not being an employee for employment tax purposes
(but not income tax purposes), regardless of the individual's actual status
under the common-law test, unless the taxpayer has no reasonable basis for
such treatment...[However, it has been] the position of the IRS, based on
legislative history, that section 530 can only apply after a determination
has been made that a worker is an employee under the common-law test."
"Under section 530, a reasonable basis for treating a worker as an independent
contractor is considered to exist if the taxpayer
(1) reasonably relied on published rulings or judicial precedent,
(2) reasonably relied on past IRS audit practice with respect to the taxpayer,
(3) reasonably relied on long-standing recognized practice of a significant
segment of the industry of which the taxpayer is a member, or
(4) has any other reasonable basis for treating a worker as an independent
contractor.
The legislative history states that section 530 is to be "construed liberally
in favor of taxpayers". Regrettably, interpretations of the safe haven definition
have differed significantly between taxpayers and the IRS; thousands of costly
and difficult controversies have arisen during the past two decades.
The procedural amendment to Section 530 of the Revenue Act of 1978 enacted
under Section 1122 of the Small Business Job Protection Act of 1996 (H.R.
3448) seeks to clarify the interpretations of these safe haven definitions;
it does not supplant either the common-law test or the Twenty Factor Test
defined in the IRS Training Manual. The highlights of this amendment stipulate:
The IRS is to advise the taxpayer of the provisions of Section 530 prior
to any audit inquiry;
- The practice of at least 25 percent of an industry shall constitute a
"significant segment" of the industry;
- A "long-standing recognized practice" need not "have continued for more
than 10 years" (and this is foreshortened for "new" industries) or to have
begun prior to 1978;
- A defined basis for shifting the "burden of proof" from the taxpayer to
the IRS;
- The applicability of the findings of prior IRS audits as precedent in
employee versus independent contractor disputes;
and
- Subsequently treating a worker as an employee does
not necessarily jeopardize the worker's status as an independent contractor
during prior periods.
While these procedural changes are helpful, they do not reduce
the employee versus independent contractor question to the three criteria
envisioned in the "Independent Contractor Tax Simplification Act." Consequently,
more companies -- large and small -- are now eschewing direct engagement of
independent contractors, and are turning to mature contract staffing services
to meet their non-permanent personnel needs. This is especially true for computer
programmers, engineers and other technical services workers where companies
strain to avoid skirmishes with the IRS over Section 1706 of the Internal
Revenue Code. Contract staffing services assume responsibility for all tax
withholdings and other human resources benefits. Sadly, this is often unappealing
to independent contractors who can no longer make health, retirement and work-related
expenses conform most economically with their individual family needs.
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All quotations are drawn from the Conference Report
104-737, August 1, 1996, accompanying H.R. 3448.