Worker Classification: How Do You Spell Relief?

By Quinn, Tina Steward; Fendley, Stanley G. | Journal of Accountancy, June 1997 | Go to article overview

Worker Classification: How Do You Spell Relief?


Quinn, Tina Steward, Fendley, Stanley G., Journal of Accountancy


THE 20-FACTOR TEST is so vague that it often gives the Internal Revenue Service more trouble than it gives taxpayers. In a study of 202 court decisions on worker classification disputes, only 41% were rules in favor of the IRS.

Source: Determination of the Employer-Employee Relationship: A Neural Network Approach to Macro-Case Analysis by Tina Steward Quinn, UMI Co., 1996.

Legislation introduced in the 105th Congress as well as a Treasury Department proposal--has brought renewed hope for progress on the perennial problem of worker classification. The legislation, which builds on a recent proposal from the American Institute of CPAs, is sponsored by Senator Christopher S. Bond (R-Mo.) and Congressman James Talent (R-Mo.), the chairmen of the congressional small business committees.

The Bond-Talent bill would establish objective criteria for determining when a worker is not an employee. By contrast, the Treasury proposal would create a second tier of safe-harbor protection under section 530 of the Revenue Act of 1978 to reduce certain retroactive tax liabilities. This article discusses both the Bond-Talent bill and the Treasury proposal and looks at each one's prospect for success in Congress.

HELP FOR THE SELF-EMPLOYED

The Bond-Talent worker classification legislation is part of a larger bill, the Home-Based Business Fairness Act of 1997 (S 460 and HR 1145), designed to benefit the self-employed. In addition to its worker classification provisions, the act would increase the medical insurance deduction for self-employed individuals to 100% of the premiums paid and expand the home office deduction.

Section 4 of the legislation deals with worker classification by establishing criteria that create a "general" safe harbor for worker classification. A worker would be treated as an independent contractor if he or she meets either an economic and workplace independence test or an alternative business structure and fringe benefits test.

Economic and workplace independence test. A worker must meet the following requirements to be treated as an independent contractor:

1. Each of the following criteria must be met:

* The worker must be able to realize a profit or loss.

* The worker must incur unreimbursed ordinary and necessary business expenses equal to or greater than 2% of his or her adjusted gross income (AGI) attributable to services performed.

* The services must be for a specific time period or project.

2. Only one of the following requirements must be met:

* The worker must have a principal place of business (a home office would qualify if used on a regular basis for essential business activities and the worker has no other place to perform these activities).

* The worker does not perform most of his or her services at one recipient's facilities.

* He or she pays market value rent for use of the service recipient's facilities.

* He or she operates primarily with equipment not supplied by the service recipient.

3. The worker must have a written contract with the service recipient that says the worker will not be treated as an employee for federal tax purposes.

Business structure and benefits test. Under this alternative, a worker would be considered an independent contractor if

1. He or she conducts business as a corporation or limited liability company.

2. The service provider receives no fringe benefits from the service recipient.

3. The parties have a written contract.

The general safe harbor will not apply if the service recipient fails to meet the applicable reporting requirements through willful neglect. Other provisions of the bill shift the burden of proof to the Internal Revenue Service if the service recipient establishes a prima facie case that it was reasonable to treat the worker as an independent contractor and the service recipient has fully cooperated with the IRS. …

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