Category Archives: Independent Contractors and Self-Employed Taxpayers

Are You Self-Employed? IRS May Think So

The question often arises as to just exactly when does the “self-employment tax” apply? After all, since this exaction clips folks at over 15% of the income in question, the answer often will mean “real money” coming out of the taxpayer’s pocket.

Generally, the self-employment tax applies to net profit (if $400 or more) derived from a “trade or business” carried on by a sole proprietor. But the determination as to whether one is engaged in a “trade or business” sometimes is open to interpretation — and dependent upon all of the “facts and circumstances” surrounding the situation.

Activities performed as an employee do not constitute self-employment, though employees obviously bear the equivalent burden of the FICA (and Medicare) taxes.

Carrying on a “trade or business” implies the taxpayer is expending his or her effort, though sporadic efforts may not qualify. Consider Rev Rul 58-112, dealing with payment of a commission to a corporate officer to negotiate the sale of his company to the payor. IRS ruled, in this case, that the chap receiving these payments did not derive self-employment income because he had never previously engaged in a similar transaction, and did not hold himself out as available for such negotiations.

Contrast this example to the case of an executive who serves on a Board of Directors and receives directors’ fees — IRS says this activity typically does give rise to self-employment income.

(Learn more: Why the Self-Employed May Be Audit Targets.)

More IRS Guidance on ‘Section 530 Relief’

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?