Here is the scenario: You hired a worker and considered that worker an independent contractor. After being audited by the IRS, you find out that they consider that worker to be an employee, and they want you to pay all the employment taxes (federal income tax, social security, and medicare) owed for that worker from hire. If this sounds like a nightmare, it might help to know that this has happened to many other employers and that the IRS has provided a possible solution to this problem, if you can qualify. Here are the details:
The IRS has set up a provision called Section 530 relief under which you will not owe employment taxes for your misclassified workers, if you meet certain requirements. You must meet all three of these requirements:
- First, you must have had a reasonable basis for not treating the workers as employees. Your reasonable basis might be:
- A court case relating to federal taxes or a ruling issued to you by the IRS
- An IRS audit during which the IRS did not reclassify the workers as employees. An audit from 1997 to present must have included an employment tax examination
- A significant section of your industry has a longstanding practice of treating similar workers as independent contractors
- You relied on the advice of a business lawyer or accountant who knew the facts of your business.
- A court case relating to federal taxes or a ruling issued to you by the IRS
- Second, you consistently treated the workers and similar workers as independent contractors during the entire time of their work, and
- Third, you must have filed all required federal tax returns consistent with your treatment of the workers as independent contractors, not employees. In other words, you prepared a Form 1099-MISC for each worker each year and submitted these forms as required.
Many of the "reasonable basis" items are subjective. What, for example, is a "significant section" of an industry? And how do you prove that your CPA advised you to treat workers as independent contractors? It is difficult, although not impossible, to obtain this Section 530 "safe harbor" relief.
In addition, if at any time you treated workers as employees, you may jeopardize the possibility of your obtaining Section 503 relief. It should also be noted that this relief does not address the responsibility of the workers themselves for paying these employment taxes.
The current law, as amended in 1986, does not make Section 503 relief available for payments made by an employer to an individual contracted out to a third party. For example, a company contracts with you for computer software assistance, and you contract out one of your workers to that company, and you bill the company for this worker's services. You cannot then qualify for Section 530 relief for payments you made to the worker.
Disclaimer: This section of the law is complex, and my purpose is only to provide an overview. I am not an attorney, CPA, or tax professional. Check with your tax adviser if you think you may be entitled to Section 530 relief.
