Businesses often seek ways to orchestrate their affairs so that employment taxes are minimized or even avoided. Internal Revenue Code Section 3121 defines the general characteristics of an employer-employee relationship. But under Section 530 of the Revenue Act of 1978, for employment tax purposes a business may treat an individual as an independent contractor, rather than an employee, if:
1. The taxpayer does not treat the individual as an employee for any period;
2. The taxpayer does not treat any other individual holding a substantially similar position as an employee for purposes of employment taxes for any period;
3. All required Federal tax returns are filed by the taxpayer on a basis consistent with its treatment of the individual as a nonemployee; and
4. The taxpayer has a reasonable basis for not treating the individual as an employee.
A taxpayer has a reasonable basis for not treating an individual as an employee for a period if the taxpayer’s treatment of that individual for that period was in reasonable reliance on one or more of the following safe harbors:
1. Judicial precedent or IRS ruling;
2. A past IRS audit; or
3. A longstanding practice of a significant segment of the relevant industry.
A question which has arisen is whether the taxpayer must demonstrate that it reasonably relied on a safe harbor before hiring the worker to perform services. And in Program Manager’s Technical Advice, IRS says that an employer need not demonstrate that it reasonable relied on a Section 530 safe harbor before engaging the worker. However, the employer may qualify for relief if it is able to show reasonable reliance on the asserted safe harbor sometime after it first engaged the worker, but before the employment period at issue.
For more information, check out the IRS publication Do You Qualify for Relief Under Section 530?