ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – NEW IRS GUIDELINES USED TO DETERMINE WORKER STATUS – WILL THEY ALSO GOVERN EDD AUDITS?
By Robert S. Schriebman
Is there a difference between the factors or guidelines used by the IRS to determine worker status when compared to the factors used by the EDD? Yes. Employers who follow IRS standards may receive an unpleasant surprise when audited by the EDD. Historically, the IRS has consistently used its well-known “20-Factor Test” to determine worker status while the EDD may use its 23-factor test and reach a different conclusion. It has been common for an employer to become whipsawed when trying to navigate between the IRS and the EDD.
Recently the IRS has sought to modernize its historic guidelines by creating three broad categories of standards. On September 15, 2021, the IRS issued a press release providing new employer guidelines. IR-2021-186, September 15, 2021.
According to the new press release, “An employee is considered to be anyone who performs services, if the business can control what will be done and how it will be done. What matters is that the business has the right to control the details of how the worker’s services are performed.”
Some Control is Always Present
There is an element of control present in most business relationships. But the “control” that requires a worker to be treated as an employee under CUIC § 621(b) is control over the details of the job as opposed to the control of the outcome.
A principal beneficially interested in work being performed has the right to retain limited controls over the manner and means of the performance of the work for limited purposes without thereby becoming an employer. See Western Indemnity Company v. Pillsbury (1916), 172 Cal. 807 at page 811; Bohannon v. McClatchy Publishing Co. (1936), 16 Cal. App. 2d 188 at page 199.
Complete abnegation of control is not essential to the establishment of a status of independent contractor. Where one person is performing work in which another is beneficially interested, the latter may exercise over the former a certain measure of control which looks to the results to be obtained without creating the relationship of employer-employee. See Bates v. Industrial Accident Commission (1958) 156 Cal. App. 2d 713, Tax Decisions Nos. 87, 115, 148, 260, 658, 1176, 1858, 1972 and 2167.
IRS Safe Harbor Rules – Revenue Act of 1978 § 530
When the safe harbor provisions apply, the employer is protected from any retroactive liability for withheld income taxes, FICA taxes and FUTA taxes. Moreover, under these provisions, workers can be treated by the employer as independent contractors without fear of reclassification by the IRS. The safe harbor provisions eliminate an employer’s liability for employment taxes arising from an employment relationship if the employer has a “reasonable basis” for not treating the subject worker as an employee.
The employer must have a reasonable basis for treating workers as independent contractors. A “reasonable basis” under § 530 includes a past IRS examination (not necessarily for employment tax purposes), if the examination entailed no assessment attributable to the taxpayer’s employment tax treatment of workers deemed to be independent contractors.
Modern Guidelines Now Used by the IRS
According to the new IRS press release, “Independent contractors are normally people in an independent trade, business or profession in which they offer their services to the public. Doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers or auctioneers are generally independent contractors.”
The new IRS “ABC Test” is as follows:
A. Behavioral Control – IRS agents will want to determine if the company controls or has the right to control what the worker does and how the worker does his/her job. This may be an exercise in frustration because, as we read above, there is an element of control in every working relationship.
B. Financial Control – IRS agents will want to know how the business directs or controls the financial and business aspects of a worker’s job. Key guidelines will be how a worker is paid and whether out-of-pocket expenses are reimbursed. Does the worker have a substantial investment in tools and equipment? This appears to be portions of the 20-factor test reworked to appear fresh and new.
C. Relationship of the Parties – Unlike the EDD, that pays virtually little or no attention to written contracts, the IRS agent will review contracts to look for benefits, such as retirement plans, life and health insurance and paid vacations. The length of the relationship will also be important.
The new IRS streamlined guidelines are vague. It will be interesting to see whether the IRS will weave the old 20-factor test into these new standards. It all comes down to money. Independent contractor means no payroll taxes. Just how many contractors will pay self-employment taxes may be problematic. In the meantime, its business as usual at the EDD.
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 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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