How to shift the burden of proof to the IRS on independent contractor status.

• Author: Jackson, Willis

Prior to the enactment of the Small Business job Protection Act of 1996 (SBJPA), Section 530 of the Revenue Act of 1978 (Section 530) prevented the IRS from arbitrarily retroactively reclassifying a business's workers as employees if the business (1) treated all similar workers as independent contractors (substantive consistency), (2) filed an proper Federal tax documents (e.g., Forms 1099) on a basis consistent with the treatment as nonemployees (reporting consistency) and (3) had a "reasonable basis" for the nonemployee classification. For this purpose, a "reasonable basis" consisted of:

* Judicial precedent, published rulings, or technical advice, letter rulings or a determination letter to the taxpayer.

* A past IRS audit (whether or not an employment tax audit) of the taxpayer in which no assessment of employment taxes was made on similarly treated individuals.

* A "long-standing" recognized practice of a "significant" segment of the taxpayer's industry (neither term was defined).

* Any other reasonable basis.

While Section 530 provided some guidance, it did not (1) address the taxpayer's burden of proof in demonstrating a reasonable basis for treating a worker as an independent contractor, (2) require the IRS to notify an employer of Section 530's requirements either before or during the course of an audit involving the classification issue or (3) address whether relief was available only after the IRS determined that a worker was an employee under common-law standards.

Need for Further Legislation

Although the courts had addressed some of these issues, sufficient controversy continued to exist prior to the enactment of the SBJPA such that Congress found it necessary to make amendments to Section 530. The SBJPA Senate Report notes that many worker classification disputes involve small businesses without adequate resources to challenge the IRS.(1) Post-SBJPA, if the taxpayer fully cooperates with reasonable requests for information from the IRS, the burden of proof should generally fall on the IRS once the taxpayer establishes a prima facie case that it was reasonable not to treat the worker as an employee.(2) For this purpose, an IRS request for information is not reasonable if (1) it does not relate to the particular basis on which the taxpayer relied for establishing reasonable basis or (2) complying with the request would be impracticable given the circumstances and costs involved.(3)

New Provisions

Prior to the SBJPA, a worker...