In an IRS Employment Tax Audit? Can Section 530 Help You?

Independent contractor audits — whether with the IRS or L&I or ESD — are notoriously tough. Indeed, even where businesses treat compliance obligations seriously, they may nonetheless fall victim to unforgiving tests and auditors.

Fortunately, for businesses in IRS employment tax audits, flunking the IRS’s independent contractor test may not be the end of the story, thanks to Section 530 of the Revenue Act of 1978, known as “Section 530.”  A recent client of mine might call it “the beautiful and the precious and the very special Section 530.”

Under Section 530, businesses that flunk the IRS independent contractor test may be protected from liability from back taxes if they can show each of the following: (1) they always treated their workers as independent contractors, and never as employees; (2) they  timely filed 1099s on the independent contractors; and (3) they had “reasonable basis” for treating their workers as independent contractors.

So what exactly amounts to reasonable basis for treating workers as independent contractors?  Fortunately, Section 530 offers several good options, and the IRS is explicitly directed to liberally construe each in favor of the taxpayer:

  • Prior rulings. i.e. judicial precedent, published rulings, technical advice with respect to the taxpayer, or a letter ruling to the taxpayer;
  • Findings in a past audit. i.e. a past IRS 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; or
  • Industry practice. i.e. long-standing recognized practice of a significant segment of the industry in which such individual was engaged.
  • Any other reasonable basis. e.g advice of an attorney or accountant; a good faith attempt to understand and follow common law rules; etc.  

A critical caveat to Section 530’s availability, however, is that a business must be able to show that it had “reasonable basis” at the time that it chose its classification. For example, if it is relying on industry practice, it must show that it chose its classification because it investigated industry practice and determined independent contractor status was the proper classification.  If relying on a judicial precedent, it must be able to show that it was aware of the precedent or ruling at the time it chose its classification. Or if it is relying on professional advice, it must show that it sought legal advice from an attorney or accountant qualified to advise on independent contractor classification, and on the basis of that advice, chose the independent contractor classification.

There is obviously much more to Section 530 that can be addressed in this post, but if you’re “fortunate” enough to find yourself in an IRS employment tax audit, look into whether “the beautiful and the precious and the very special Section 530” is available to you. It can be a godsend, and if you can qualify, it protects your business for life.

Note that Section 530 only provides safe harbor in IRS audits.  It provides no protection in audits by state agencies.  Thus, a business seeking to address compliance should consider Section 530 protection in addition to other strategies/practices geared at complying with state tests.

For more information on how to comply with independent contractor obligations, consult with an experienced independent contractor law attorney, and check out 1099 Review™, a Mercer Law PLLC product, and Washington’s State’s first online independent contractor risk assessment tool and resource center.

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