Information provided by the NECA.
Background
Beginning in the late 1960s and early 1970s, the IRS stepped up auditing compliance with employment tax laws out of concern that the Social Security trust funds were not being adequately replenished though the collection of Social Security taxes, The agency also perceived that many independent contractors were failing to pay their share of self-employment tax. The result of this policing was that many independent contractors were reclassified as employees.
However, an employer backlash ensued, and, ultimately, Section 530 of the Revenue Act of 1978 was enacted and incorporated into the Internal Revenue Code in response to complaints that the IRS was too aggressive with respect to worker classification issues. It was originally intended as a temporary measure but was made permanent by the Tax Equity and Fiscal Responsibility Act of 1982 under President Reagan.
Section 530 is a so-called “safe harbor” provision. It prevents the IRS from retroactively reclassifying “independent contractors” as employees and subjecting the principal to federal employment taxes, penalties and interest for such misclassification.
In order for an employer to qualify for section 530 relief, it must have:
(1) Consistently treated the workers (and similarly situated workers) as independent contractors;
(2) Complied with the Form 1099 reporting requirements with respect to the compensation paid the workers for the tax years at issue; and
(3) Had a reasonable basis for treating the workers as independent contractors.
Unfortunately, qualifications #1 and #3 are somewhat subjective in nature and hard to define. When conflicts arise with respect to these qualifiers, the issue is usually decided in favor of the taxpayer because of the “sense of congressional intent.” (That is, because Section 503 arose out of pro-taxpayer legislation.)
And, while the IRS has taken the position that the 1099s must be timely filed before Section 530 relief is available, this position has been rejected by the courts, finding no such requirement under the plain language of the statute.
Therefore, many employers use the Section 503 loophole to avoid paying FICA (Social Security and Medicare) and FUTA (unemployment) taxes on their workers, and to forgo the background-checking, record-keeping, and payroll-accounting burdens associated with genuine employees. Although the national extent of employee misclassification is unknown, earlier national studies and a few more recent ones suggest that it is a significant and growing problem.
The last time the IRS undertook a comprehensive analysis of worker misclassification was for tax year 1984. At that time, the IRS estimated that nationally about 15 percent of employers misclassified a total of 3.4 million employees as independent contractors, resulting in an estimated revenue loss of $1.6 billion (in 1984 dollars). More recently, the federal Government Accountability Office estimated that employee misclassification resulted in the underpayment of an estimated $2.72 billion in Social Security taxes, unemployment insurance taxes and income taxes in 2006, the latest year for which figures are available. And, there is anecdotal evidence that the problem is escalating in these tough economic times.
Legislative Remedy
Over the past 10 years or so, many bills to correct the Section 503 loophole have been introduced in Congress. (Even President Obama offered one in 2007 as a freshman senator from Illinois.) NECA has supported these efforts and, even though none of them reached a floor vote, we are enthusiastic about the prospects for the two related bills introduced in the current (111th) Congress.
Last July, Rep. James McDermott [D, WA-7] introduced HR 3408, the Taxpayer Responsibility, Accountability, and Consistency Act. It has 26 co-sponsors, all Democrats.
In December, Sen. John Kerry [D, MA] introduced a bill of the same name that is listed as S 2882. It currently has six co-sponsors from the Democratic party.
This legislation seeks to amend the Internal Revenue Code to:
(1) Require businesses to report to the IRS all payments of $600 or more made to corporate providers of property and services;
(2) Set forth criteria and rules relating to the treatment of workers as employees or independent contractors; and
(3) Increase penalties for failure to file correct tax return information or comply with other information reporting requirements.
In addition, the legislation would require the Secretary of the Treasury to issue an annual report on worker misclassification.
"This is about leveling the playing field and ensuring that America's workers receive the protections and pay they deserve," said Sen. Kerry. "We cannot continue to reward businesses that refuse to play by the rules."