Finance News & Insights

Your company misclassified a worker: Do you qualify for IRS relief?

Another day, another high-profile – and high-cost – misclassification lawsuit makes the news.

It seems with the growth of the gig economy, it’s getting even trickier to classify workers with 100% confidence. And that uncertainty can lead to compliance issues and substantial fines.

So, what happens when one day, your company realizes an independent contractor (IC) you paid should actually have been an employee?

The key is to gather documentation quickly, so you can avoid some costly consequences. In the case of worker reclassification, your company may be eligible for IRS Section 530 relief from federal employment tax obligations … if you meet three specific criteria.

Review  those three statutory requirements below (and share them with A/P, Payroll and HR) to ensure you’re covered and ready:

1. Reporting Consistency

Your company must be able to show that you “timely filed” information returns consistent with its previous classification of the worker. In other words, if A/P had paid the worker as an IC, you have to prove that you filed accurate, timely 1099-MISCs for the taxable year(s) in question.

(Tell finance staffers: That’s just one more reason why filing year-end forms on time, consistently, is so vital!)

2. Substantive Consistency

To get relief, your company also must prove that it never treated the worker – or “any worker holding a substantially similar position” – as an employee.

Example 1: John was hired as an employee, then (wrongly) reclassified as an IC. The company later finds out John’s misclassified. It may not be eligible for relief since John was acknowledged as an employee in the past.

Example 2: Sally (an employee) had similar duties to Katie (an IC). During an audit, the company’s told that Katie is misclassified. IRS may say that you’re not eligible for relief because both women held “similar positions” but were classified differently.

3. Reasonable Basis

Lastly, your company must demonstrate that it relied on one of four “safe havens” for treating the worker as a non-employee:

  1. Prior audit. The audit must have been “an examination for employment tax purposes of the status of the class of workers at issue or a substantially similar class of workers.” Essentially, a previous audit must have approved of the way you classified the worker (or similar workers) in question.
  2. Judicial precedent. As support, you can use a federal precedent/ruling that examines a similar situation and supports your decision to classify a worker a certain way. (Note: IRS says state court decisions and rulings of other agencies don’t create judicial precedent.)
  3. Industry practice. Your company can also show that it relied on an established, standard practice of your industry. (IRS generally defines “industry” as “firms located in the same geographic or metropolitan area which provide the same product or service and compete for the same customers.”)
  4. Other reasonable basis. If you fail to meet the first three safe havens, you could still get relief if you can show you relied on some other reasonable basis for treating the worker as an IC instead of an employee. According to IRS, that may include 1) reliance upon advice from an accountant or attorney, 2) common law rules, or 3) prior state administrative decisions or other federal determinations.

The bottom line: If you can support your classification decisions with reasonable explanations and solid documentation, you may be able to avoid scrutiny and fines.

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