I. Clarifying the Confusion Surrounding Section 530 of the Revenue Act of 1978
Testimony offered at the hearing grossly distorts the application of Section 530 of the Revenue Act of 1978 (“Section 530”). The allegation was made that companies that misclassify individuals as independent contractors can obtain protection in doing so by simply convincing at least 25 percent of their industry colleagues to join in the misclassification. For the reasons set forth below, that allegation is incorrect.
Before addressing the technical operation of Section 530, it is important to appreciate the reason why the provision was enacted. Section 530 was enacted "to alleviate what was perceived as overly zealous pursuit and assessment of taxes and penalties against employers who had, in good faith, misclassified their employees as independent contractors."1
A. Section 530 – An Overview
Section 530 established relatively objective criteria that, if satisfied, would protect a business in its treatment of service providers as independent contractors. To qualify for Section 530 protection, a taxpayer must satisfy three requirements, namely, (i) it must comply with Form 1099 reporting requirements with respect to the covered workers,2 (ii) it must never have treated any worker holding a position substantially similar to the covered workers as an employee for federal employment-tax purposes (the “substantive consistency requirement”),3 and (iii) its treatment of the covered workers as independent contractors must be in reasonable reliance on what is commonly referred to as a “reasonable basis”.4 Reasonable basis can be established in various ways,5 one of which is by establishing that the treatment is in reasonable reliance on a long-standing practice of a significant segment of an industry.6
B. The Form 1099 Reporting Requirement of Section 530
Of the three requirements of Section 530, Form 1099 compliance is admittedly not problematic. To satisfy this requirement, a business need only report the payments made to workers whom it treats as independent contractors on Forms 1099.
C. The Substantive Consistency Requirement of Section 530
The substantive consistency requirement, however, can be highly problematic. Judicial decisions have made clear that this requirement has no de minimis exception.7 This means that if a company were to treat so much as one individual as an employee for one hour of service (by reporting the compensation paid to the individual for that one hour on a Form W-2), such treatment would forever disqualify the company from Section 530 protection with respect to not only that specific individual but also any other individual who holds a position substantially similar to the position held by that individual.
To make it even more difficult for a company to qualify for Section 530 protection, the substantive consistency requirement looks back all the way to 1978. Thus, if a company treated a worker as an employee for any tax period beginning after December 31, 1977, that treatment would forever disqualify the company from Section 530 protection with respect to any individual holding a position substantially similar to the position held by that worker. Furthermore, the provision also takes into account predecessor businesses. Thus, if one business treats an individual as an employee, that violation of the substantive consistency requirement would disqualify not only that business but also any successor business.
It follows that quite contrary to the testimony offered on this issue at the hearing, a company that treats an individual as an employee for federal employment-tax purposes cannot simply reclassify that individual to independent-contractor status and convince other businesses to follow suit and then qualify for Section 530 protection –because neither the company nor the other businesses that also reclassified similar workers as independent contractors could satisfy Section 530’s substantive consistency requirement.
D. The Requirements of the “Industry Practice” Safe Harbor
The statutory requirements of the “industry practice” reasonable basis betray yet another flaw in the explanation of Section 530 that was given at the hearing. This particular reasonable basis can be established if a taxpayer’s treatment of an individual as an independent contractor was in reasonable reliance on a long-standing recognized practice of a significant segment of the industry in which such individual was engaged.8 The Small Business Job Protection Act of 1996, Pub. L. No. 104-188, § 1112(a), 110 Stat. 1759, clarified the requirements of this particular reasonable basis by amending Section 530 to provide that the requirement that an industry practice be “long-standing” shall not be construed as requiring the practice to have continued for more than 10 years.9 Thus, for an industry practice of treating a particular type of worker as an independent contractor to qualify as long-standing, for purposes of Section 530, the treatment must have continued for approximately 10 years.
It follows that even if – as the hearing testimony suggests – a company could convince its competitors to reclassify a certain type of worker to independent-contractor status, Section 530 protection would not become available, assuming the other Section 530 requirements also are satisfied, until after the passage of approximately 10 years following the date on which the other competitors joined in the reclassification, in order for the industry practice to qualify as “long standing”. The realistic probability of this actually occurring, moreover, is remote, because the other competitors would likely be reluctant to reclassify individuals from employee status to independent-contractor status, as they would be ineligible for Section 530 protection with respect to the reclassified workers because they could not satisfy the substantive consistency requirement (for the reasons discussed above).
E. The Requirement that Reliance on a Safe Harbor be “Reasonable”
A final defect in the oversimplification of the “industry practice” safe harbor of Section 530 that was offered at the hearing is its failure to consider the requirement that a taxpayer’s reliance on a safe harbor be “reasonable.”10 This means that a company’s reliance on a safe harbor for purposes of treating an individual as an independent contractor will not be respected for purposes of Section 530 unless that reliance is reasonable.
It follows that the testimony at the hearing suggesting that even clearly incorrect misclassifications of individuals as independent contractors could nonetheless be protected by Section 530 ignores the requirement that a taxpayer’s reliance on a safe harbor be “reasonable”.
F. Current Requirements of Section 530 Provide Adequate Protection against Potentially Abusive Application of the Provision
As the foregoing demonstrates, the actual requirements a business must satisfy in order to qualify for Section 530 protection provide ample protection against the blatant misuse of the provision that was described at the hearing.
Discussions of Section 530 often elicit more heat than light. Those who are opposed to independent-contractor status find Section 530 vexing because it actually works very well in protecting taxpayers that in good faith treat an individual as an independent contractor and have a reasonable basis for doing so. Efforts to discredit Section 530 by offering up wild and flagrant worker misclassifications that Section 530 allegedly protects should be scrutinized; such offerings commonly fail to consider all of the requirements the Congress imposed for Section 530 protection to be available. In other words, Section 530 sets forth clear and adequate standards for independent-contractor classification. Misclassification of employees as independent-contractors, if and when it occurs, can best be counteracted by more effectively enforcing Section 530, rather than by amending it or passing redundant legislation.
1. Boles Trucking, Inc. v. United States, 77 F.3d 236,239 (8th Cir. 1996). Section 530 was temporarily extended twice and then extended indefinitely by § 269 of the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, 96 Stat. 324, 552, § 269. Section 530 was never codified.
2. Section 530(a)(1)(B).
3. Section 530(a)(1)(A) and (a)(3).
4. Section 530(a)(1) and (2).
5. Section 530(a)(2).
6. Section 530(a)(2)(C).
7. See, e.g., Institute for Resource management, Inc. v. United States, 90-2 U.S.T.C. ¶50,586 (Cl. Ct. 1990).
8. Section 530(a)(2)(C).
9. Section 530(e)(2)(C).
10. E.g., Marlar, Inc. v. United States, 151 F.3d 962, 966; 1998 U.S. App. LEXIS 17764 (9th Cir. 1998). The court explained:
As an initial matter, we must agree with the government that, under § 530, any reliance on industry practice must be "reasonable." As Congress provided, in no uncertain terms:
[A] taxpayer shall in any case be treated as having a reasonable basis for not treating an individual as an employee for a period if the taxpayer's treatment of such individual for such period was in reasonable reliance on any of the following:
. . . .
(C) long standing recognized practice of a significant segment of the industry in which such individual was engaged.
Revenue Act of 1978, § 530(a)(2) (emphasis added). The text unmistakably requires "reasonable reliance," not just mere reliance. When "the statute's language is plain, 'the sole function of the courts is to enforce it according to its terms.'" United States v. Ron Pair Enters., Inc., 489 U.S. 235, 241, 103 L. Ed. 2d 290, 109 S. Ct. 1026 (1989) (quoting Caminetti v. United States, 242 U.S. 470, 485, 61 L. Ed. 442, 37 S. Ct. 192 (1917)).
