'Section 530' Employment Tax Exemption Explained

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The three basic requirements ³ for a taxpayer to obtain section 530 relief are as follows:

1. REPORTING CONSISTENCY.

All federal tax returns (including information returns) "required" to be filed by the taxpayer with respect to the worker must be timely filed on a basis consistent with the worker not being an employee. See section 530(a)(1)(B). This requirement is known as the "reporting consistency rule."

We note from the agent's report that * * * failed to timely file Forms 1099 for its workers in * * *. * * * * * *'s failure to timely file these returns clearly violates the reporting consistency rule under the express language of section 530, rendering it ineligible for section 530 relief for taxes attributable to * * *. The Service and the Courts have applied the reporting consistency rule in a number of instances to bar section 530 relief. See e.g., Rev. Rul. 81-224, 1981-2 C.B. 197 (Taxpayer treated workers as non-employees but did not timely file Forms 1099-NEC (now 1099-MISC)); General Investment Corp. v. U.S., 823 F.2d 337 (9th Cir. 1987).

2. SUBSTANTIVE CONSISTENCY.

The taxpayer (or any predecessor) must not have treated any worker holding a substantially similar position as an employee, for employment tax purposes, after December 31, 1977 (the "substantive consistency rule"). See section 530(a)(3). Two groups of workers are treated as holding substantially similar positions if their job functions, duties, and responsibilities are similar and the control and supervision exercised by the party for whom the workers perform services is similar.

We found no information concerning whether * * * complied with the substantive consistency rule in the agent's report. This should be confirmed through discovery.

3. REASONABLE BASIS.

To establish a reasonable basis, the taxpayer must have REASONABLY relied on any one of three "safe havens" (judicial precedent, prior Service audit, industry practice) when it decided not to treat a worker as an employee. See section 530(a)(2). Although a taxpayer may be able to show the existence of one or more safe havens, the taxpayer must be able to show that it RELIED on the safe haven.

An employer who fails to meet any of these safe havens may still be entitled to relief if it can be demonstrated that some other reasonable basis existed 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. 1748, 95th Cong., 2nd Sess. 4 (1978), 1978-3 C.B. (Vol.1) 633.

a. INDUSTRY PRACTICE.

According to * * *'s Fourteenth Affirmative Defenses, * * * seeks to satisfy the reasonable basis requirement of section 530 under the industry practice safe haven. It alleges, on information and belief, that its practice of treating its workers as independent contractors was "consistent with a longstanding, recognized custom and practice of a significant segment of the '* * *' industry in New York City."

Under section 530(a)(2)(C), the taxpayer has the burden of establishing industry practice based on objective, substantiated criteria. Isbell Enterprises, Inc. v. U.S., No. B-79-141 (S.D. Tex. 1982). The taxpayer must show that it RELIED on the practice. In addition, "where various segments of an industry are using contradictory practices, logic and the law dictate that there is no "long-standing recognized practice." Martin L. Springfield dba Douglas Motors v. U.S., 873 F.Supp. 1403 (S.D. Cal. 1994) appeal pending, (used car salespersons erroneously treated as independent contractors).

Absent from * * *'s defense is any allegation that it RELIED on industry practice in deciding to treat its workers as independent contractors. Absent reliance on the industry practice, * * * has not satisfied the industry practice safe haven under section 530.

b. OTHER REASONABLE BASIS.

In its Fifteenth Affirmative Defense, * * * alleges, generally, that it had a reasonable basis for classifying its drivers as independent contractors. We found no explanation concerning this unspecified "reasonable basis," and * * * fails to allege that it relied on this reasonable basis in deciding to treat its workers as independent contractors.

Some examples of other reasonable bases that * * * may assert in support of its affirmative defense include: (1) reliance on the advice of accountant; (2) a reasonable reading of the common law rules; and (3) "good faith." We recommend nailing down, through discovery, whatever other reasonable basis that * * * intends to assert as soon as possible. After you have determined what other basis, if any, * * * intends to rely on, we would be willing to address it in a supplemental letter.

1. SUBSTANTIVE CONSISTENCY RULE (Admissions * * *)

* * * asks the government to admit that * * * treated its drivers as independent contractors rather than as employees for the years * * *, * * *, * * *, * * *, * * *, * * *, * * *, * * *. It also asks the government to admit that it did not treat any of its drivers as employees for payroll tax purposes after * * *.

As a technical matter, * * * did not define the term of art "treat." For example, do these admissions ask the government to admit that Forms 1099 were issued?; that no withholding of employment taxes was effected?; that no employee benefits, such as retirement plan contributions, were provided?; that Forms W-2 were not issued?. Accordingly, an objection could be interposed that the requests are vague and ambiguous in that "treat" is not defined.

Under Rev. Rul. 85-18, the Service provides guidelines in interpreting the term "treat" when determining whether an employer did not treat a worker as an employee. If an employer withholds employment taxes from an worker's wages, the employer has treated the worker as an employee. If an employer files employment tax returns (e.g., Forms 940, 941, W-2) concerning a particular worker, the employer has treated the worker as an employee. Although determining whether an employer did not treat a worker as an employee is analogous to determining whether an employer treated a worker as an independent contractor (* * *'s requests), a distinction can be made. Because * * * did not define "treat," the scope of the admission is not clear, especially if treat means that the Forms 1099 were timely filed.

We don't have enough information to determine whether the request should be admitted or denied on a substantive basis. This information should be obtained through discovery, using the guidelines in the preceding paragraph.

2. REPORTING CONSISTENCY RULE (Admissions * * *, * * *, * * *, * * *, * * *).

* * * asks the government to admit, essentially, that it timely filede its Forms 1099 for tax years * * * and * * *. * * * also asks the government to admit that it filed information returns for its workers on a basis consistent with its treatment of the workers as "not being 'employees.'"

The agent's report indicates that the Forms 1099 were not timely filed, at least for * * *. The government should confirm whether or not Forms 1099 were timely filed for * * *. If Forms 1099 were not timely filed, section 530 relief is not available. We understand, however, that the penalties for late filing were abated and that your office is investigating why the penalties were abated. The reason for abatement may or may not undercut the government's position on filing, but we would be interested in further discussions when the investigation is complete. Until then, we recommend taking the position that the late filing of Forms 1099 bars section 530 relief.

3. INDUSTRY PRACTICE SAFE HAVEN (Admissions * * *, * * *, * * *).

* * * asks the government to admit that the "* * * * * *" in the New York City metropolitan area, defined as * * *, is the relevant industry for purposes of section 530 relief. See request number 56. However, a factual inquiry about industry practices must be made with emphasis being placed on the breadth of the competitive area within which a business operates. See General Investment Corp., 823 F.2d at 340. A plaintiff's industry consists of the businesses that compete for the same customers and provide the same or similar product or service, and generally consists of businesses located in the same geographic or metropolitan area. Thus, before admitting this request, consideration should be given to whether the taxi industry or other transportation businesses should be included within the relevant industry.

* * * asks the government to admit that in * * *, * * *, and * * * there existed a long-standing, recognized practice of a significant segment of the * * * in New York City to treat * * * as independent contractors. Assuming arguendo that the * * * in New York City is the relevant market in this case for section 530 purposes, an admission to this request would provide * * * with an ultimate fact supporting its claim for section 530 relief.

Presumably, * * * relies on the affidavit of * * * in support of its position that there was a long standing, recognized practice in the * * * of treating * * * as independent contractors. However, the * * * affidavit states that the practice applies to "* * *," rather than simply "* * *," which are the subject of the requests for admission numbers 14 and 38. While this technical distinction may allow the government to deny the request for admission, the * * * affidavit will ultimately have to be countered with other evidence, assuming, of course, that the * * * is the relevant industry. We also note that the * * * affidavit does not define * * *.

² P.L. 95-600, section 530 (as amended by P.L. 96-167, P.L. 96-541, P.L. 97-248 and P.L. 99-514). Section 530 is an "off-Code" provision. In CCH publications, the complete text is reproduced in' the legislative history following I.R.C. section 3401(a).

³ In addition to the three requirements, it is important to note that section 530 applies only after the workers at issue are determined to be employees. If there is no employment tax liability (e.g., the workers are independent contractors), there is no basis for section 530 relief. See e.g., Galbraith and Green, Inc. v. U.S., 80-2 USTC paragraph 9629 (D. Ariz. 1980).