New laws and attitudes make independent-contractor classification less taxing for many firms.
Horror stories sell. Just ask Stephen King's publisher -- or the staff of the Senate Finance Committee. The panel garnered heavy media attention recently for two rounds of hearings on alleged abuses by the Internal Revenue Service (IRS).
But, in contrast to past hearings on IRS (mis)deeds, there was no horror story this time about companies that had treated workers as independent contractors. That was probably no coincidence: both the law and IRS attitudes have changed. If you have shied away from using owner-operators because you feared IRS retaliation, it's time to take another look.
For years, businesses were at the mercy of individual IRS examiners (agents or revenue officers). These officials typically had little or no familiarity with business practices, yet they had to interpret 20 very ambiguous factors in deciding whether the firm was legitimately treating a worker as an independent contractor.
If the examiner ruled that the worker should have been an employee, the company could then try to show it was eligible for a "safe harbor" because it had a "reasonable basis" for its treatment of a worker, such as "reasonable reliance" on a long-standing recognized industry practice. These slippery concepts understandably led to many drawn-out disputes, sometimes with ruinous consequences for the company as interest, penalties, and legal bills mounted.
What has changed? In part, the IRS did. The National Office several years ago began working with a handful of industries, including household goods movers, to shorten the list of 20 factors, rank them, and make them more relevant to a specific industry and occupation. The resulting "market segment understanding" (MSU), now in near-final form, should make employment tax audits much less uncertain.
More important, a company should be able to tell before engaging a driver whether the IRS is likely to classify that person as an independent contractor or an employee based on information the company has in hand. Although this MSU document applies only to van operators in the moving industry, many of the concepts fit other trucking segments and should help them achieve greater certainty as well.
The IRS also has tried to upgrade training for examiners and make it more uniform, so that audit results are more likely to be consistent from one part of the country to another. (Both the latest draft of the movers' MSU and the training manual are available on the IRS Web site.) And the agency created an "early appeals" process to resolve disputes faster, as well as a "classification settlement program" to provide more uniform settlement offers for companies that agree to treat their workers as employees in the future.
Congress stepped in, too. In 1996, it clarified and slightly broadened the "safe harbors." Last year, Congress granted taxpayers the right to take employment tax disputes to Tax Court, which may allow for cheaper and faster resolution of some cases. (But don't expect Congress to write a clear-cut definition of "independent contractor" itself. The tax-writing committees have rejected all such attempts for 20 years; 1998 will be no exception.)
The bottom line: None of these changes give a business carte blanche to treat everyone as an independent contractor. It's especially hazardous to "convert" an employee to independent status, unless you can demonstrate major changes in the financial and personal relationship between the worker and the company.
In any case, a firm's decision to use contractors or employees should be driven by the underlying economics, not the tax law, let alone how an IRS examiner might interpret it. But it's refreshing to have a better idea of what the IRS interpretation should be, and to have quicker recourse to administrative and judicial appeals if the examiner's interpretation doesn't match yours.
