TaxProphet Hot Topics - January 1997

January 1997 Hot Topics

INDEPENDENT CONTRACTORS: A COMPARISON BETWEEN FEDERAL AND CALIFORNIA LAW

Section 530 - The Federal Exception Preventing the IRS from Reclassifying Workers as Employees

In 1978, Congress mandated that the IRS stop reclassifying workers as employees provided the company had "any reasonable basis" for treating the worker as an independent contractor. Section 530 of the Revenue Act of 1978. Since it was intended to be a temporary measure, Sec. 530 was never codified as part of the Internal Revenue Code , but it has continued in effect since enactment. Because it was not part of the Internal Revenue Code, Section 530 does not apply to independent contractor status disputes with California. Despite an impressive string of taxpayer victories under Sec. 530, the IRS continued to insist on a restrictive interpretation of this exception.

As part of the Small Business Act, Section 1122, Congress clarified and expanded the scope of Sec. 530 (described below). Section 530 is available to companies that treated workers as independent contractors, if -

The company always treated the particular worker as an independent contractor and the general class of workers performing similar work as independent contractors;

After 1978, the company filed all returns (including information returns) required for the worker and all such returns were consistent with independent contractor status; and

The company had a "reasonable basis" for treating the worker as an independent contractor.

There are 3 express safe harbors associated with the reasonable basis standard -

A judicial precedent, published rulings or technical advice or letter ruling to the employer;

A prior IRS audit in which no assessment was made on account of improper treatment of the worker; or

A long-standing recognized practice of a significant segment of the industry in which the individual worked.

The federal courts greatly expanded the reach of Section 530 and, recently, Congress followed suit. Unfortunately, California never adopted Section 530 and so the treatment of the same worker by the IRS and California could be inconsistent. It is California, rather than the IRS, that causes most of the tax problems for small companies in this difficult area.

NOTE: The balance of this article has been incorporated into the Tax Prophet's Action Guide entitled, "Employee Stock Options - A Primer" described below:

Independent Contractor vs. Employee - A Primer
This Action Guide is the product of the author's extensive experience in negotiating stock options as part of the compensation package paid to employees and contractors. In addition, the author represents several taxpayers who confronting huge tax bills stemming from the exercise of employee options and the subsequent crash of the stock market.
This Action Guide defines the key terms and concepts involving both incentive stock options (ISO's) and non-qualified stock options, identifies the tax-triggering events and discusses strategies to minimize the tax impact. The guide discusses the alternative minimum tax as applied to ISOs as well as sophisticated tax-planning concepts. This guide is a must read for employee or company that receives stock options as part of their compensation.

| Home Page | Search | E-mail Form | Firm Profile |

**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**