The IRS often contests an employer’s classification of workers as independent contractors as opposed to employees. If a worker is labeled as an independent contactor, the employer does not have to pay its fair share of federal payroll taxes, nor does it have to provide costly fringe benefits available to employees. This can result in significant savings.
Fortunately, your business may be able to fall back on a fail-safe rule called “Section 530 relief.” This refers to a provision in a 1978 law, not a section of the Internal Revenue Code.
Key information: For 2022, the Social Security portion of payroll tax is 6.2% of the first $147,000 of an employee’s wages, while the 1.45% tax for the Medicare portion applies to all their wages. When you multiply these amounts for a group of workers, you can easily see what is at stake,
Volumes have been written about the distinctions between independent contractors and employees, but it essentially boils down to the degree of control the employer exerts over the worker. If you dictate how the worker performs the job, they are generally treated as an employee. On the other hand, if the worker is basically operating on their own, they may qualify as an independent contractor.
Section 530 relief may come into play when a business is assessed back taxes and penalties for misclassifying workers as independent contractors. Briefly stated, if the employer can show it had a reasonable basis for treating workers as independent contractors, the additional taxes and penalties may be waived.
Specifically, to qualify for Section 530 relief, your business must meet the following three requirements.
1 Reasonable basis: You must have a reasonable basis for not treating workers as independent contractors. This might be established by one of the following:
- A related court case or IRS ruling.
- A prior IRS audit involving examination of payroll taxes at a time when you treated similar workers as independent contractors and there was no IRS reclassification of these workers.
- A significant segment of your industry treats similar workers as independent contractors.
- You are relying on some other reasonable authority (e.g., the opinion of an attorney or CPA familiar with the business operation).
2 Employment status consistency: In the past, the employer has always, without exception, treated the workers and any similar workers as independent contractors.
3 Reporting consistency: The employer has consistently treated the workers as independent contractors on federal tax returns. For instance, your business must have provided workers with Form 1099s. If you had W-2s prepared for only some of the workers in the group, your claim will be denied.
Be aware that you must meet all three requirements. If you slip up on just one, Section 530 relief is not available.
Finally, if you are not sure you are correctly treating workers as independent contractors, you can ask the IRS for a determination on Form SS-8. Have your JMF professional tax advisor guide the way.
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