The Fifth Circuit has upheld a district court's finding that a construction company's workers were employees rather than independent contractors. The company's late filing of Forms 1099 for the affected workers didn't meet the reporting consistency requirement for Section 530 relief and its workers were employees under the common law tests. Although IRS failed to provide statutory notice of Section 530 relief before or at the start of its audit, the company didn't try to obtain administrative relief on this ground.
Background. Whether a worker is an independent contractor or employee generally is determined by whether the enterprise he works for has the right to control and direct him regarding the job he is to do and how he is to do it. Under the common-law rules (so-called because they originate from court cases rather than from the Code), factors used to determine if an individual is a common law employee are:
- The degree of control exercised by the principal;
- which party invests in work facilities used by the individual;
- the opportunity of the individual for profit or loss;
- whether the principal can discharge the individual;
- whether the work is part of the principal's regular business;
- the permanency of the relationship;
- the relationship the parties believed they were creating; and
- the provision of employee benefits.
However, Section 530 of the '78 Revenue Act (as amended) provides retroactive and prospective relief from employment tax liability for employers who misclassified workers as independent contractors using the common-law facts and circumstances standards. Section 530 applies only if:
- The taxpayer does not treat an individual as an employee for any period, and does not treat any other individual holding a substantially similar position as an employee for purposes of employment tax for any period—the substantive consistency requirement;
- for post-'78 periods, “all federal returns (including information returns) required to be filed by the taxpayer” with respect to the individual for such period “are filed on a basis consistent with the taxpayer's treatment” of the individual as a nonemployee—the reporting consistency requirement; and
- the taxpayer had a “reasonable basis” for not treating the worker as an employee (judicial precedent or IRS rulings, a past IRS audit, or a long-standing practice of a significant segment of the relevant industry)—the reasonable basis requirement.
IRS must provide a taxpayer with written notice of the provisions of Section 530 before or at the start of any audit relating to the employment status of one or more individuals who perform services for the taxpayer. (Sec. 530(e)(1), P.L. 95-600, as amended by Sec. 1122(a), P.L. 104-188) However, where the portion of an audit involving worker classification issues doesn't arise until after the examination of the taxpayer has begun, IRS does not have to give the notice until the time the worker classification issue is first raised with the taxpayer. (Conf Rept No. 104-737 ( P.L. 104-188 ), p. 204)
Facts. Bruecher Foundation Services, Inc. (BFS), performed residential foundation repair and grading projects, and treated the workers who did the manual labor on its projects as independent contractors. An IRS audit found that, for the tax years ending Mar. 31, 2000 and Mar. 31, '99, BFS had claimed substantial deductions for “contract labor” on its Form 1120 income tax returns but had not filed any corresponding Form 1099s for particular contractors. The auditor referred the matter to IRS's employment tax group, which commenced an employment tax audit of BFS without telling the company it was doing so. IRS did not provide BFS with notice of the statutory worker classification safe harbor as it was required to do by law. The audit summary also carried IRS's conclusion that BFS was not entitled to the Section 530 safe harbor because it failed to file Form 1099s for the workers at issue.
Following various administrative proceedings, IRS issued a tax lien against BFS on Dec. 13, 2005, and executed a levy against its bank account on Mar. 23, 2006. On May 17, 2006, BFS filed Form 1099s for the workers at issue for calendar years '99 and 2000, then took its dispute to a district court, which found that the workers were employees. BFS then appealed to the Fifth Circuit. It argued that: (1) the district court erred in concluding that BFS was not entitled to rely on the Section 530 safe harbor to avoid liability for any misclassification of its employees; (2) if it is not entitled to Section 530 relief, then the district court should have assigned the burden of proof at trial to the government because IRS failed to comply with the advance-notice procedures of Section 530; and (3) failing other grounds for reversal, its workers were not employees.
Fifth Circuit rules for IRS. The Fifth Circuit rejected each of BFS's arguments, as follows:
- Section 530 relief. BFS raised the interesting argument that there was no time limit specified for when it could file Form 1099 for the workers at issue and thus satisfy the second test for Section 530 relief. The Fifth Circuit concluded that BFS couldn't meet its threshold burden of showing that the assessment was erroneous under Section 530. BFS conceded that it was not entitled to Section 530 protection until it filed the relevant Form 1099s. When the tax was assessed, it had not done so and the assessment was therefore correct when made. While the appellate court declined to address the question of whether Section 530 requires the timely filing of the relevant Form 1099s to obtain the benefit of the safe harbor, it held that the practical effect of waiting until after the conclusion of the IRS's administrative process and the concomitant assessment of the tax was to preclude BFS from successfully raising Section 530 as a defense in this subsequent judicial proceeding.
- Burden of proof. BFS argued that IRS's admitted failure to comply with the Section 530 notice procedures reversed the usual burden of proof to put the burden on the government. BFS conceded that there was no authority for this proposition and asked the Fifth Circuit to create this remedy. The Fifth Circuit declined to do so, quoting the Supreme Court's holding in United States v. James Daniel Good Real Property, 510 U.S. 43, 63 (1993), that if “a statute does not specify a consequence for [the government's] noncompliance with statutory timing provisions, the federal courts will not in the ordinary course impose their own coercive sanction.” The Fifth Circuit said it didn't mean to suggest that there can never be a remedy for the IRS's failure to comply with the Section 530 notice procedures. It said the resolution might, for example, have been different had BFS asserted a violation of its due process rights stemming from the failure to provide notice. But that wasn't the case since BFS was apprised of IRS's determination as to the non-applicability of the Section 530 safe harbor at the conclusion of the audit, allowing BFS ample opportunity for administrative relief on those grounds.
- Workers were employees. The Fifth Circuit found that the workers had no risk of loss, virtually no investment in facilities, and were not in business for themselves, all indications of an employment relationship. BFS's moderate degree of control over the workers and the relatively low skill level required only weakly supported employment. The final criterion—the degree of permanence of the relationship, which varied from worker to worker—favored neither employment nor independent contractor status on the facts. Viewing all these factors together, the Fifth Circuit held that the district court did not err in finding that the workers were BFS's employees for federal employment tax purposes.
The significance of this is that the business owner had to pay not only the FICA and Medicare tax he should have paid originally, but the employees FICA and Medicare tax and the Federal withholding which should have been withheld plus penalties and interest. Frequently this will bankrupt the business and often the individuals who own the company and follow them for 10 years.