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Senate Finance Committee Considering Measure to Largely Repeal IRC Section 530 Safe Harbor for Most Businesses Using Independent Contractors

On July 8, 2014 by Schnader in Labor and Employment

By Scott J. Wenner

Sen. Sherrod Brown (D.Ohio) reintroduced the “Fair Playing Field Act,” S.1706, in November 2013. The bill, which first appeared in 2010 under then-Senator John Kerry’s sponsorship, purports to close an ostensible loophole in the application of the common law test generally used by the Internal Revenue Service to determine whether a worker is properly classified as an independent contractor. The purported loophole referred to by Sen. Brown and his predecessor sponsors is Section 530 of the Internal Revenue Code, which the bill would repeal for workers who do not provide professional services. The bill defines “professional services” as services performed in the fields of health, law, engineering, architecture, accounting, actuarial science, consulting, or financial services and insurance.

Section 530 of the Internal Revenue Code

Far from a mere “loophole” that permits big companies to cheat, Section 530 provides important protections for businesses, many of which are small, whose business model was and remains built around legitimate use of independent contractors, including independent sales representatives and mystery shoppers. Many of these businesses maintain that they have relied on Section 530 in growing their businesses, and that its repeal would have devastating consequences for them because, e.g., they cannot afford to employ a national network of workers who may work just a few hours at a time, two or three times per year, distributing surveys or undertaking some similar task. Moreover, because in many cases entire industries treat workers in a specific position as independent contractors using Section 530, one central thesis of the legislation – that some companies gain an unfair competitive advantage by misclassifying a position – in fact fails to justify repeal of Section 530.

Section 530 was added by Congress to the Internal Revenue Code by the Revenue Act of 1978. Under the Section 530 safe harbor, a qualifying employer is not responsible for payment of past employment taxes for workers who the IRS determines have been misclassified. Further, that employer is not required to reclassify such workers. The safe harbor permits an employer to continue to treat workers the IRS finds to have been misclassified as independent contractors for purposes of federal employment taxes so long as the employer satisfies the requirements of the safe harbor:

  • The employer consistently must have filed Forms 1099 for all those whom it classified as independent contractors.
  • The employer must treat each group of workers that holds similar positions consistently. That is, it must treat all workers holding substantially similar positions as independent contractors.
  • The taxpayer must have a “reasonable basis” for treating the workers in those positions as independent contractors. “Reasonable basis” includes reliance on court cases, published IRS rulings, an IRS ruling received by the employer, a past IRS audit that made no assessment on the class of workers at issue, by showing that a significant segment of the taxpayer’s industry treats similar workers as independent contractors, or some other reasonable basis.

Fair Playing Field Act

In addition to the repeal of Section 530’s safe harbor with respect to most positions, the Fair Playing Field Act would

  • Repeal the existing moratorium on IRS guidance addressing worker classification;
  • Permit the IRS to prospectively reclassify workers as employees;
  • Limit the IRS’s discretion to reduce penalties for misclassifying employees where a “reasonable basis” (defined above) does not exist. Presumably, this would affect the IRS’s authority to continue its Voluntary Classification Settlement Program, which we discussed here.

The bill, which has been stalled in the Senate Finance Committee, will be taken up in the form of an amendment by Sen. Brown to a bill entitled Preserving American’s Transit and Highway Act (PATH). PATH was introduced to provide revenue and authorize expenditures for the Highway Trust Fund, which purportedly will run out of money this year. Sen. Brown has linked the Fair Playing Field Act to PATH by making the increased misclassification penalties to be collected – estimated at $5.8 billion over ten years – a source of funding for the highway trust.

The Senate Finance Committee has scheduled a July 10 mark up session for PATH, including making decisions on which of the plethora of amendments to include. If the committee adopts the Fair Playing Field amendments and PATH is favorably reported out, it will go to the Senate floor for a vote. If passed with the Fair Playing Field amendments included, it still must gain House approval, which appears unlikely. Nonetheless, it is important to know that the Democrats’ effort on this legislation continues, and that monitoring of the campaign to narrow the lawful use of independent contractors continues to be a good idea.