This is the second article in a series dedicated to using Section 530 of the Revenue Act of 1978 as protection for businesses that have been using independent contractors, in good faith, but are now facing an IRS or State of Minnesota audit of that practice. Section 530 may be 34 years old, but it is still a viable option for many businesses.
Section 530 relief is available to a business that treats workers as independent contractors if the following tests are met.
- Reporting Consistency. The taxpayer files all requisite tax returns on a basis consistent with treatment as independent contractors;
- Substantive Consistency. The taxpayer has treated all workers holding substantially similar positions as independent contractors; and,
- Reasonable Basis. The taxpayer had a reasonable basis for treating the workers as independent contractors.
In this article, we focus on the first of these three elements, Reporting Consistency. This is sometimes referred to as the “Tax Return Test.” All Federal tax returns must be filed on a basis consistent with treatment of the workers as independent contractors. This means that the business must file Forms 1099 for each worker it is claiming to be an independent contractor.
What if the business files Forms 1099 for some periods and not others? The business may still pursue Section 530 relief for the periods where it filed the Forms 1099.
Who carries the burden to prove the returns were filed? The burden is on the taxpayer to prove that the returns were filed and received by the IRS. Even if the taxpayer filed the returns, the IRS can argue that it did not receive the returns. The attorney representing the business should collect the returns from the taxpayer and request verification from the IRS that the returns were received.
Are the Forms 1099 the only relevant returns? Some courts have found that the required returns include both the Forms 1099 and the transmittal Form 1096. See Medical Emergency Care Associates v. Comm'r. 120 T.C. 436, 444 (2003). Fortunately, Rev. Proc. 85-18 mentions only the Form 1099.
What if the returns are filed late? While it does not appear that the returns must be filed timely, they should be filed before the IRS starts an audit of the taxpayer on the independent contractor issue. Compare Medical Emergency Care Associates v. Comm'r. 120 T.C. 436, 444 (2003) (late filing before the audit started did not preclude section 530 relief) and Bruecher Foundation Services, Inc. v. U.S. , 484 F. Supp.2d 600, 603 (W.D. Tax. 2007) (filing returns after the audit started precluded Section 530 relief).
What if the business filed Forms W-2 for the workers? If the business filed Form W-2 for the workers, the presumption will be that the business treated them as employees.
What if the IRS forces the business to file a Form 941 and include the worker as an employee? If the IRS requires a business to file a Form 941, Employment Tax Return, as part of an audit, the filing is considered involuntary and the business may still pursue the Section 530 relief. On the other hand, if the business files the Form 941 in response to an IRS notice that it has not received a Form 941 and asks that it be filed, that filing will be considered voluntary and the business will be precluded from pursuing Section 530 relief. See F.J. O'Hara and Sons, Inc. v. U.S., 562 F. Supp. 100, 101 (1983).
What is the impact of the business complying with state filing requirements? Compliance with state filing requirements for employees will not impact the business's ability to pursue Section 530 on the federal level.
What if the business made no payments to the workers? Is a Form 1099 still required? Courts have found in situations where the worker controls the money, like a taxi cab driver, Howard's Yellow Cabs, Inc. v. U.S., 987 F. Supp. 469, 479 (1997) that the business did not have to file a Form 1099. The court has also looked to industry custom to determine if 1099s were required. In JJR Inc. v. U.S. 950 F. Supp. 1037, 1045-46 (W.D. Wash. 1997) the court found that Forms 1099 were not required.