Payroll Insights

June 2008

Special Issue

Independent Contractor Classification Legislation
Introduced in Congress

The Taxpayer Responsibility, Accountability, and Consistency Act of 2008 (H.R. 5804), sponsored by Rep. Jim McDermott (D-WA) and co-sponsored by 31 others, has been introduced to provide procedures for proper classification of employees and independent contractors, by changing the reporting regime under section 6041 of the Internal Revenue Code (IRC), modifying and codifying the safe harbor sections of Section 530 of the Revenue Act of 1978 (Revenue Act Section 530), and strengthening the penalty provisions of sections 6721 and 6722.

Section 6041 currently requires businesses that receive services from an individual (i.e., a sole proprietor or a partnership) valued at more than $600 per year to report payments to the Internal Revenue Service (IRS). The proposed legislation would amend section 6041 by:

• Adding a new provision subjecting payments made to a corporation to the requirements of IRC Section 6041(a), which requires businesses making payments of $600 or more to a person in any taxable year to report such payments and recipient information to the IRS. This provision would apply to payments made more than one year after the date of enactment.

Revenue Act Section 530 currently provides businesses with relief from federal employment tax obligations in the event of an identified misclassification of workers, if certain requirements, such as reasonable basis, substantive consistency, and reporting consistency, are met. The proposed legislation would codify Revenue Act Section 530 in new IRC section 3511, with certain changes. These changes include:

• Adding a provision that would prevent the application of the safe harbor provision to an individual for any periods beginning after the date of notice of a determination that such individual should be treated as an employee of the taxpayer.
• Eliminating employers’ ability to rely on a long-standing recognized practice of a significant segment of the industry in which the individual is engaged ( “industry practice”) as a basis for claiming the Revenue Act Section 530 safe harbor.
• Modifying employers’ ability to rely on judicial precedent, published rulings, or technical advice with respect to the taxpayer, or a letter ruling to the taxpayer, as a basis for claiming the Revenue Act Section 530 safe harbor. The bill would allow a taxpayer to rely only on a written determination (as described in section 6110(b)(1)) issued to the taxpayer addressing the employment status of the individual at issue or another individual holding a substantially similar position with the taxpayer. The taxpayer could no longer rely on judicial precedent, published rulings, technical advice, or a letter ruling issued to the taxpayer.
• Adding a provision limiting employers’ ability to rely on examinations and written determinations issued within seven years of the period at issue. This provision would apply to any periods beginning after the date of enactment of the bill and would apply to services rendered more than one year after enactment.
• Modifying the provision addressing substantially similar positions to require that determinations made as to whether an individual holds a position substantially similar to a position held by another individual must be made in a manner consistent with the Fair Labor Standards Act of 1938.
• Eliminating the provision which prevents the application of the safe harbor provision to an individual who, pursuant to an arrangement between the taxpayer and another person, provides services for such other person as an engineer, designer, drafter, computer programmer, systems analyst, or other similarly skilled worker engaged in a similar line of work.
• Modifying the burden of proof under the safe harbor provisions to require that the taxpayer establish entitlement by a preponderance of the evidence.
• Adding a provision requiring the Secretary of Treasury to establish administrative procedures, within a year of enactment, allowing any individual who performs services for a taxpayer to petition the government for a review of his or her employment status. This petition may be done personally or through a designated representative or attorney. These procedures must provide for: (1) a determination of status within 90 days of filing in industries where employment is transient, casual, or seasonal (e.g., the construction industry); and (2) an administrative appeal.
• Adding a provision that would prohibit retaliation (discharge, refusal to contract, or otherwise discriminate against an individual with respect to compensation, terms, conditions, or privileges of the services provided) because the individual or the individual’s representative has filed a reclassification petition with the government. Other state, federal, and collectively bargained rights would not be diminished by this provision.
• Adding a provision that would address the results of a misclassification determination. If a determination is made that a worker has been misclassified, the Secretary of Treasury must inform the Department of Labor about the misclassification and notify the individual of any eligibility for the refund of self-employment taxes.
• Adding a provision requiring the Secretary of Treasury, within one year of enactment, to prescribe such regulations as may be necessary and appropriate to carry out the purposes of section 3511.
• Adding a provision changing a reference in section 7436(a)—which addresses proceedings for determination of employment status—from Revenue Act Section 530 to IRC section 3511.
• Adding a provision making Revenue Act Section 530 inapplicable to services rendered more than one year after the date of enactment.
• Adding a provision that would require the Secretary of the Treasury to issue annual reports on worker misclassification. The reports would include: (1) information on the number and type of enforcement actions against and examinations of employers who have misclassified workers; (2) relief obtained as a result of such actions against, and examinations of, employers who have misclassified workers; (3) an overall estimate of the number of employers misclassifying workers, the number of workers affected and the industries involved; (4) the impact of such misclassification on the federal tax system; and (5) information on the outcomes of the petitions filed under the new IRC section.

These provisions would apply to services rendered more than one year after enactment, unless stated otherwise.

The legislation would also increase penalties for failure to file correct information returns under section 6721 and failure to furnish correct payee statements under section 6722. These increases would apply to information returns required to be filed after December 31, 2008.

This legislation was referred to the Ways and Means Committee on April 15, 2008, following the bill’s introduction. A companion bill has not yet been introduced in the Senate.

Contact Us Our area leaders in the Employment Tax Practice are interested in your feedback, including any topics you might like to see addressed in future issues. Scott Schapiro Principal Tysons Corner, Virginia 703-286-8267 sschapiro@kpmg.com Michael Svoboda Principal Los Angeles, California 213-955-8861 mjsvoboda@kpmg.com Subscribe to Payroll Insights If you aren't already a subscriber, click here to send an e-mail request to be added to our mailing list.