ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – IRS “SAFE HARBOR” RULES ARE NOT LIMITED TO ONLY ISSUES OF WORKER STATUS
By Robert S. Schriebman
The IRS so-called “Safe Harbor” rules are known as “Section 530 Relief.” Section 530 is not a section in the Internal Revenue Code. It was enacted as part of the Revenue Act of 1978, Pub. L. No. 95-600, sec. 530, 92 Stat. at 2885. As a young tax lawyer, I became familiar with Safe Harbor Relief in one of my first cases involving worker status issues and the ongoing, never ending battle to reclassify independent contractors as common law employees. Whenever I attended a continuing education seminar, on any topic relating to employment tax issues, I was exposed to Section 530 and always looked upon this 1978 legislation as solely confined to worker classification issues. That’s all my learned colleagues talked about. The learned instructors never discussed how this safe harbor relief is used to establish the true identity of an employer.
Thanks to a recent US Tax Court case, my knowledge has been expanded. I learned that Section 530 can also be used as a safe harbor on legal issues involving whether or not an acknowledged employee may or may not be the employee of a specific employer. This may sound like double talk, but there are real issues out there involving just who a person’s employer is. These issues do not involve whether a worker is an employee or an independent contractor. There is no doubt that the worker is an employee period! But who is that employee’s employer? That is why this case is both unique and important.
On August 3, 2020, the US Tax Court issued a decision in the case of Reflectxion Resources, Inc. v. Commissioner, TC Memo 2020-114. Thisarticle will discuss the complex holding in this case and will look at an area of Section 530 that very few have paid attention to.
The Case of Reflectxion Resources, Inc.
The case involved the issue of who employs therapists for purposes of assessing additional payroll taxes. Reflectxion Resources, Inc. (R) is a staffing agency for physical and occupational therapists. It refers these therapists to medical facilities throughout the nation. It works hand-in-hand with a third-party co-employer I will refer to as G. For eleven out of sixteen payroll tax quarters, G treated the therapists as its own employees and filed quarterly payroll tax returns and paid over withholdings to the IRS. For the last five quarters R took over the payroll compliance. The therapists were paid reimbursements for travel related expenses that were not reported by G as wages subject to employment taxes.
The IRS conducted an audit of both R and G, and assessed additional payroll taxes, penalties and interest for these reimbursements. Under Florida law both R and G were considered co-employers. The IRS issued an assessment against R for these additional payroll taxes, etc.
R disagreed with the proposed assessment.
Upon completion of the audit, the IRS did not issue to R the usual Deficiency Notice (90-Day letter), but instead issued a Notice of Determination of Worker Classification (NDWC) pursuant to IRC § 7436. R contended that G was entitled to safe harbor treatment under Section 530 because the therapists were not R’s employees. They were G’s employees and therefore, the assessment should have been issued to G as the primary employer of the therapists. If additional payroll taxes are to be owed, G should pay them, not R.
The US Tax Court, in its opinion, did not decide the issue of the taxability of the travel reimbursements. Rather, it had to decide whether it had jurisdiction to hear the case and whether or not Section 530 applied to the issue of who was the employer. There was no question that the therapists were employees; there was no issue of worker status. The only real issue was which company employed them. The issue of liability will be left for a future Tax Court hearing.
The US Tax Court Has Jurisdiction to Hear This Case
Jurisdiction for the Tax Court to hear cases usually comes by way of a 90-Day letter or Deficiency Notice. Jurisdiction may also arise under IRC § 7436, Proceedings for Determination of Employment Status. As a result of an IRS audit, an actual controversary occurs when the taxpayer disagrees with a determination that one or more individuals performing services are its employees, or the taxpayer is entitled to relief under Section 530 of the Revenue Act of 1978. In R’s case, an actual controversary existed as a result of an audit and as to questions involving who is an employee’s employer. If a taxpayer claims Section 530 Safe Harbor Relief, but the IRS disagrees, that disagreement will also give the Tax Court jurisdiction. R disagreed that G’s admitted employees were R’s employees according to the IRS. R also sought 530 Safe Harbor Relief as to who the employees belong to.
Safe Harbor Rules Can Be Used to Identify the Proper Employer
Here I will discuss the basics of Section 530 and its use as a defense to establish the identity of the actual employer.
Section 530 Basics
If a worker is correctly characterized as an independent contractor, the employer will not owe additional payroll taxes. However, if a worker is correctly characterized as an employee, the employer may owe payroll taxes. The line between the correct status of a worker as an employee or an independent contractor is not at all clear. If an employer has incorrectly characterized an employee as an independent contractor, there may be assessments of payroll taxes, penalties and interest.
Where the 1978 legislation applies, Section 530 gives the employer relief from employment taxes, even though the actual employment relation would have required the payment of those taxes.
Use of Section 530 to Establish the Identity of the Actual Employer
Section 530 provides in part as follows:
“SEC. 530. CONTROVERSIES INVOLVING WHETHER INDIVIDUALS ARE EMPLOYEES FOR PURPOSES OF THE EMPLOYMENT TAXES.
- Termination for Certain Employment Tax Liability
- In general. – if –
- for purposes of employment taxes, the taxpayer did not treat an individual as an employee for any period * * *, and
- in the case of periods after December 31, 1978, all Federal tax returns (including information returns) required to be filed by the taxpayer with respect to such individual for such period are filed on a basis consistent with the taxpayer’s treatment of such individual as not being an employee,
then, for purposes of applying such taxes for such period with respect to the taxpayer, the individual shall be deemed not to be an employee unless the taxpayer had no reasonable basis for not treating such individual as an employee.”
Source: US Tax Court case page 16.
Under the above statute three elements must be met in order for the employer to be relieved of liability:
- The employer did not treat an individual as an employee.
- The employer must have filed tax returns “on a basis consistent with the taxpayer’s treatment of such individual as not being an employee.”
- There must have been a reasonable basis for not treating the worker as an employee.
All three requirements must be met in order for the employer to qualify under Section 530. Section 530 treatment is available only where the taxpayer did not treat the individual worker as an employee.
In the Reflectxion case, R did not report G’s employees as its own. R is seeking a ruling that any payroll taxes assessed, as the result of worker reimbursements, should be assessed against G. In other words, R’s workers are R’s workers, and G’s workers belong to G as its employees. R should not be taxed on G’s workers. This is what the case is all about.
R should be allowed to assert Section 530 safe harbor relief in order to establish the true identity of the employer. This case is unique because it uses safe harbor relief for situations that do not involve worker classification issues.
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 40 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 and 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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