Copyright © 1995 Robert L. Sommers
Nannygate
Reconsidered:
Nannygate may have vanished from the front pages, but it
has caused unnecessary concern -- even panic -- among government
officials and our citizens. What originally was a violation of
immigration law by Zoe Baird has evolved into a White House
inquisition into the hiring practices of household workers,
regardless of immigration status. Many citizens are concerned
that by hiring a neighbor's teenager as a baby-sitter or by using
a housekeeper on a part-time basis, they were required to file
the federal information return (Form 942) and pay Social Security
and Medicare taxes on their "employees." Contrary to
the position taken by both the IRS and numerous tax commentators,
the vast majority of part-time domestic workers are independent
contractors; therefore, taxpayers are under no obligation to file
tax returns and pay taxes on them.
In reality, the tax issue is straightforward: Is a
household worker an "employee" or an "independent
contractor?" Unfortunately, the answer is buried deep within
the caverns of our tax laws, and involves a federal statute
curiously omitted from the tax code and never mentioned in the
Form 942 instructions. In recent years, Congress and the courts
have radically redefined the law with respect to whether a worker
is an independent contractor or an employee. The traditional
common-law test, still embraced by the IRS and those tax
commentators who have written on Nannygate, involves the issue of
worker control: Are the services of the household worker subject
to the taxpayer's will and control over what must be done and how
it must be done? In Revenue Ruling 87-41, 1987-1 CB 296, the IRS
developed 20 factors used to determine whether a worker is an
independent contractor under the common-law test.
The IRS's conventional approach, however, has been
clearly superseded by Federal statute and recent court
interpretations. Now, the proper inquiry is not the degree of
taxpayer control over the worker, but rather, has the taxpayer
consistently treated the worker as an independent contractor, and
did the taxpayer have any reasonable basis" for such
treatment? If the answers are yes, then the IRS is prevented from
reclassifying the worker as an employee.
Section 530
In 1978, responding to aggressive attempts by the IRS to
reclassify workers from independent contractors to employees,
Congress enacted Section 530 of the Revenue Act of 1978 (26 USC
Sec. 3401 note). Under Section 530, the IRS is bound by the
taxpayer's classification, provided the taxpayer (1) filed all
necessary tax and information returns; (2) consistently treated
the worker as an independent contractor and (3) had "any
reasonable basis" in determining that the worker was an
independent contractor. Congress directed that the reasonable
basis standard should be "construed liberally in favor of
the taxpayer." General Investment Corporation, 823 F. 2d 337
(CA-9, 1987). Although there are no reported cases involving
household workers and Section 530, the IRS in Rev Proc. 85-18,
1985-1 CB 518, has acknowledged the validity of Section 530 in
general and, specifically, its application to all taxes imposed
on an employer -- including IRC Sec. 3111 Medicare and Social
Security taxes involving household employees.
But Section 530 contains a major hurdle: to qualify for
relief, taxpayers must not have "treated" household
workers as employees, something done by filing Form 942. Because
Section 530 does not permit an employee to be later reclassified
as an independent contractor, those who may have panicked and
innocently filed Form 942 have probably done themselves
irreparable damage by irreversibly classifying a worker as an
employee.
Section 530 states that the "any reasonable basis"
standard may be satisfied by meeting any of three statutory
"safe havens." These safe havens are, in general: (1)
judicial precedent and published IRS rulings, whether or not they
relate to the particular industry or business in which the
taxpayer is engaged; (2) a past IRS audit of the taxpayer where
no assessment was made regarding employment taxes of workers
holding positions substantially similar to the position held by
the worker whose status is at issue; and (3) a long-standing
recognized practice of a significant segment of the industry in
which the worker was engaged -- although the practice need not be
uniform throughout the entire industry.
These safe havens are not exclusive; the taxpayer may
demonstrate a reasonable basis in some other manner. As the
following cases demonstrate, the courts have liberally construed
Section 530 in favor of taxpayers; in fact, taxpayers have won
every case under Section 530 in which a legitimate controversy
existed! In Queensgate Dental Family Practice v. U.S., 91-2 USTC
50,536 (DC-PA, 1991), a corporation relied on a Pennsylvania
Dental Board decision that it could not legally treat its
licensed dentists as employees; the court found that such
reliance was reasonable under Section 530. The court stated that
the inquiry was simply whether the taxpayer's beliefs and
decisions regarding his treatment of individuals as either
employees or independent contractors were reasonable and made in
good faith. Similarly, in Darrell Harris, Inc., 770 F. Supp 1492
(DC-Okla, 1991), the court stated that the "any reasonable
basis" test under Section 530 was met by a taxpayer's good
faith showing in determining whether its workers were independent
contractors. The Queensgate court also stated that Section 530
was enacted explicitly to eliminate the need for courts to engage
in the traditional common-law practice of balancing complex
factual issues in deciding whether an individual is an
independent contractor or employee. The threshold inquiry is
whether the taxpayer is entitled to relief under Section 530. If
Section 530 applies, then the court need not apply the 20-factor
test set forth in Revenue Ruling 87-41, supra, to determine
worker control under the common-law. If Section 530 is
unavailable -- because the taxpayer either: (1) failed to
consistently treat the worker as an independent contractor; (2)
had no reasonable basis for treating the worker as an independent
contractor; or (3) failed to file all necessary tax returns --
then the taxpayer must prove its case under the common law
approach taken by the IRS.
In Critical Care Registered Nursing Inc. v. U.S., 91-2
USTC 50,481 (DC-PA, 1991), the taxpayer supplied specialist
registered nurses to hospitals for temporary additional staffing
and treated the nurses as independent contractors. The court held
that the taxpayer could apply the traditional worker control
tests to establish that it had a reasonable basis for treating
the workers as independent contractors. The taxpayer did not have
to prove by a preponderance of the evidence that its workers were
independent contractors; it only needed to show that it had a
"reasonable basis" for treating the workers as
independent contractors under the traditional common law tests
for worker control. This decision greatly expanded the
application of Section 530 and severely undercut the IRS's
ability to prevail in independent contractor controversies.
In REAG, Inc., 801 F. Supp 494 (DC-Okla, 1992) the court
held that under Section 530, the taxpayer need only show a
"substantial rational basis" to meet its burden of
proof for its decision to treat a worker as an independent
contractor. This new standard fell somewhere between the usual
taxpayer standard for prevailing under the preponderance of the
evidence burden of proof and the usual IRS burden of proof of a
prima facie showing of correctness. The string of pro-taxpayer
decisions has continued. In the recent case of Apollo Drywall,
Inc. v U.S., 1993 U.S. Dist. Lexis 5611 (April 6, 1993), the
court ruled that the IRS's interpretation of Section 530 was not
"substantially justified" and awarded attorney fees and
costs to the taxpayer under 26 USC Section 7430. The decisions
in Critical Care Registered Nursing, Inc. and REAG, Inc., which
constitute judicial precedent under the first safe-harbor above,
provide the legal justification for classifying most part-time
baby-sitters, housekeepers, gardeners, and other household
workers as independent contractors. Some common-law tests
applicable to a part-time household worker may include whether
the worker: (1) works part-time for any one person; (2) works for
one or more unrelated persons at the same time; (3) negotiates
dates, times and hours for the work; (4) is paid on a per-job
basis; (5) is free to accept or decline assignments; (6) offers
his or her services to the public (such as through advertising or
classified ads); (7) works in teams, uses helpers or delegates
the work to someone else; (8) uses his or her own tools and
equipment; (9) is hired to produce a certain result (a clean
house, a well-groomed garden) and is not given step-by-step
instructions for accomplishing the task; (10) is not trained to
perform the services in a particular manner by the person hiring
the worker; and (11) does not have a continuing relationship with
the person hiring the worker. Remember, the taxpayer's burden of
proof has been substantially lowered -- if several of these
factors demonstrate independent contractor status, that should be
enough to satisfy the "any reasonable basis test" under
Section 530.
In fact, taxpayers with full-time household workers may
still obtain relief -- under the second or third safe haven
above. Also, Rev. Ruling 77-279, 1977-2 IRB 12, held that even an
individual providing full-time child-care services was engaged in
an independent trade or business. This constitutes a published
ruling under the "judicial precedent and published IRS
ruling" safe haven described above, and thus it may be
applicable to full-time or part-time child care and baby-sitters.
Although the worker in Rev. Ruling 77-279 provided child care in
the worker's own home, this was not a factor in the IRS ruling.
Conclusion
Before a taxpayer files Form 942, he or she must consider
whether Sec. 530 and the subsequent court cases offer a
"reasonable basis" for treating his or her household
workers as independent contractors. The confusion of Nannygate
(compounded by the illegal work status issues) should not trap
taxpayers into an irreversible filing. Section 530 was enacted to
protect taxpayers from the IRS on these issues -- they should use
it.
