ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY ALL ABOUT IRS SAFE HARBOR RULES – PART 3

By Robert S. Schriebman

2025

INTRODUCTION

This is part three of a three-part series discussing the ins and outs of IRS “Safe Harbor” rules also known as Section 530. Before going into specifics, it must be understood that these rules relate only to IRS audits. There is no similar Safe Harbor legislation for EDD audits. In EDD worker status audits, it is common to have an inconsistency wherein the employer is properly treating workers as independent contractors for IRS purposes but not for the EDD. In other words, the EDD will find the worker to be a common law employee requiring a W2 instead of a 1099.

There are new rules modifying Section 530 that are now found in IRS Rev. Proc. 2025-10. The old rules set forth in Rev. Proc. 85-18 are now obsolete.

You’ll not find Section 530 in the Internal Revenue code. It was enacted by the Revenue Act of 1978, (Pub. L. No. 95-600, 92 Stat. 2763). Originally enacted as a temporary measure, it was extended indefinitely by the Tax Equity and Fiscal Responsibility Act of 1982.

WHAT DOES SECTION 530 SAY?

Section 530 provides that an employer will not be liable for Federal employment taxes, with respect to an individual or class of workers if certain statutory requirements are met. Under Section 530, the employer, not the worker, is eligible for relief from the employment tax liability that would otherwise apply in the Internal Revenue Code.

Section 530 (a) generally provides that if the employer did not treat a worker as an employee for any period, then the worker will be deemed not to be an employee for that period, unless the employer had no reasonable basis for not treating the worker as an employee. As a requirement for this relief, the employer is required to file all federal tax returns (including information returns) required to be filed by the employer with respect to the worker for the period and are filed on a basis consistent with the employer’s treatment of the worker as not being an employee, and, the employee has not treated any other worker holding a substantially similar position as an employee for purposes of employment taxes. Section 530 prevents the IRS from reclassifying certain workers as employees whom the taxpayer has treated as independent contractors.

THE ELEMENTS OF SECTION 530 RELIEF

There are many elements that must be satisfied before the Safe Harbor rules apply. Let’s look at them:

1. The employer must treat the worker as an independent contractor. The employer is also required to file all required federal tax returns including information returns. This means the employer must file quarterly and annual payroll tax returns such as Forms 941 and 940. The employer must also issue all required information returns such as W2, W3, 1096, and 1099.
2. The employer must be consistent in the treatment of the worker. The employer must not treat designated employees the same way the contractor is treated. In other words, the employer cannot have employees doing substantially the same jobs as the contractor.
3. The employer must have a reasonable basis for not treating the worker as an employee. Here are some examples of the reasonable basis requirements.

1. A judicial decision or published rulings and technical advice from the IRS. If the employer has a private letter ruling, this will suffice.
2. A past IRS audit of the taxpayer in which there was no assessment attributable to the treatment of other designated employees holding substantially similar positions. There have been substantial changes to this rule which were discussed in Part 2.
3. Long-standing recognized practice of a significant segment of the industry in which that worker was engaged, or
4. If the employer had some other reasonable basis for not treating the worker as an employee.

In this part three, I will review reasonable basis requirements under Section 530 (See element 3 above).

REASONABLE BASIS REQUIREMENT

To obtain Safe Harbor Relief for workers treated as independent contractors, the employer must satisfy the reasonable basis requirements provided in Section 530(a) and (e). This requires the employer to demonstrate that he/she reasonably relied on one of the Safe Harbors or had another reasonable basis for treating the worker as a non-employee. The employer has the burden of proof. The IRS considers the following when determining whether the reasonable basis standard has been met.

1. A judicial precedent or published IRS ruling. This requires that the employer reasonably relied upon the judicial precedent or published ruling at the time the employer began treating the worker as an independent contractor.
2. A past IRS audit that resulted in no assessment of employment taxes attributable to the employment status reclassification of employees doing substantially similar work as that done by the contractor.

1. There were changes made to this standard in the Small Business Job Protection Act of 1996, Pub. L. No. 104-188. This law added new section 530(e). If an employer is relying on the results of an audit that began after 1996, the audit must have been an employment tax examination of the same contractors, or contractors holding substantially similar positions, that did not result in a reclassification of the same contractors holding substantially similar positions. This is a major change in the Safe Harbor rules. An employer does not meet this Safe Harbor if the relationship between the employer and the contractor during the period under audit is different than that which existed at the time of the prior audit.
2. A long-standing recognized practice of a significant segment of the industry in which the employer was engaged. An industry generally consists of businesses located in the same geographic or metropolitan area that compete for the same customers. Twenty-five percent (25%) of the employer’s industry is deemed to be a significant segment of the industry. A lower percentage may be a significant segment, depending on the facts and circumstances. A practice that has existed for ten years is deemed to be long-standing. A shorter period may qualify depending on the facts and circumstances.

The legislative history of Section 530 states that the reasonable basis requirement should be construed liberally in favor of the employer.

Consistent with the legislative history of Section 530, an employer is not considered to have a reasonable basis for the treatment of workers as non-employees if the facts and circumstances indicate negligence, or an intentional disregard of the rules and regulations.

CONCLUSION

For further information, please review Rev. Proc. 2025-10 as well as Rev. Proc. 85-18.

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Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 50 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD, and he is not employed by the EDD or any other agency of the State of California.

Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners a6502nd the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.

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