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Over 50 Years In Practice
Over 500 Articles

Independent Contractor Or Employee?



By Robert S. Schriebman, SJD

When the California Employment Development Department (EDD) notified my new client that she was about to be audited for treating workers as independent contractors instead of employees, my new client was not worried. She let me know, most emphatically, that she will most likely receive a “pass” by the EDD because of so-called safe harbor rules. Is my new client right?

What does “safe harbor” mean? Generally it means that the EDD must recognize that the business has followed a consistent and long time treatment of workers as independent contractors, and because of this consistency, the business should be allowed to continue this treatment in the future. This, however, is an over simplification. To find out what safe harbor really means we have to go back to the year 1978. The safe harbor rules are found in Section 530 of the Federal Revenue Act of 1978. Notice I said “Federal.” There is no California equivalent.

Section 530 gave taxpayers certain safe havens as a result of controversies then existing between taxpayers and the IRS on the classification of worker status. If the employer has a “reasonable basis” for not treating workers as employees the IRS is required to recognize this reasonable basis and leave things as they are with the workers acknowledged as independent contractors.

What is “reasonable basis” under Section 530 for not treating an individual as an employee? There are three avenues of relief available to the employer:

1. There must be a judicial precedent, published ruling, or other IRS announcements.

2. A past IRS examination (not necessarily for employment tax purposes) of the taxpayer, even if that audit did not result in any type of employment tax assessment.

3. Long-standing recognized practice in the taxpayer’s industry.

The taxpayer-employer must have a “reasonable basis” BEFORE a worker is treated as an independent contractor. See the U.S. Tax Court case of Peno Trucking Inc v Commissioner, TC Memo 2007-66, (Reversed 296 Fed Appx 449, 6th Cir 2008).

I find that most of my clients conclude that they have a reasonable basis for treating a worker as an independent contractor because of what they believe to be a long-standing recognized practice in their industry.

My new client is very confident that the EDD will go away because she has one or more of the above safe harbor exceptions in her favor. She simply wants me to write a letter to the friendly EDD auditor assigned to her case and state, in substance, that the EDD should find someone else to audit.


The EDD knows all about IRS safe harbor laws. It understands the value of judicial precedent, and it is also aware that taxpayers strongly believe that the way they conduct business is according to custom in their respective industries – but that is as far as it goes. A client must understand that the State of California does not have a Revenue Act of 1978 and does not have the safe harbor rules set forth in Section 530. In other words, to the EDD there is no such thing as safe harbor. There are certain laws and regulations that treat workers in specific industries as independent contractors. For example, real estate salespersons are recognized as independent contractors. However, the list of exempt industries is short and the tests are narrow. Most EDD auditors pay no attention to what the taxpayer perceives to be long-standing recognized practices in the taxpayer’s industry. As far as the EDD is concerned, the taxpayer bears a very strong burden of proof that there is such an industry standard.

The EDD has an audit manual entitled TAX AUDIT GUIDELINES that you can download from the EDD website. In Chapter IX of the manual you will find 23 factors used by the EDD to determine worker status. Factor 21, of the 23 factors, discusses custom in the industry as follows:

“If the work is traditionally performed by employees under the direction of a supervisor, it is an indication of employment.”

“If the work is usually performed by independent contractors, it is an indication of independence.”

Admittedly, these guidelines are not very helpful. EDD administrative case law offers a bit more insight. It is clear that fruit pickers who are supervised by farm staff are employees. On the otherhand, medical doctors working in hospital emergency rooms are generally treated as independent contractors. No doubt your case is somewhere between these two extremes.

In conclusion, please understand that the EDD does not recognize, and does not pay attention to, IRS safe harbor guidelines set forth in the Revenue Act of 1978. Unfortunately, taxpayers who believe that they will be relieved from an EDD audit due to safe harbor rules are believing in a myth.

© Copyright 2011. No part of this article may be taken and used in any way whatsoever

without the express written consent of Robert S. Schriebman

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.