Sixth Circuit reverses Tax Court in employment classification dispute

Reversing the Tax Court, the Court of Appeals for the Sixth Circuit recently held that an employer was eligible for "Section 530 relief" from employment tax liabilities. The Tax Court correctly classified drivers as employees of a trucking company but improperly denied Section 530 relief.

Background. To say that the employee-or-independent contractor issue remains a hot issue is an understatement. Nonpayment and underpayment of employment taxes has been identified by the IRS and other federal agencies as contributing at least $45 billion to the tax gap. By misclassifying employees as independent contractors, employers contribute to the tax gap by evading federal payroll taxes.

Many employers unintentionally misclassify employees simply because they are confused by the conflicting worker classification rules. The confusion is understandable since federal and state laws may define the term "employee" differently and use various tests to differentiate between employees and independent contractors.

Courts, too, have added to the uncertainty in this area by interpreting the rules in slightly different ways. The latest case is in the Sixth Circuit, which covers Kentucky, Michigan, Ohio, and Tennessee. While different circuit courts of appeals give great weight to one another's opinions, they are not bound to follow them.

Drivers. In 2003, the IRS determined that drivers engaged by the taxpayer were employees and not independent contractors. The IRS also denied Section 530 relief to the taxpayer. The taxpayer appealed to the Tax Court. Losing there, the taxpayer appealed to the Sixth Circuit.

Code Sec. 530 of the Revenue Act of 1978 is a safe harbor for employers. Generally, the employer must not have treated the worker as an employee and have filed all relevant federal tax returns. Additionally, the employer must have had a reasonable basis for not treating the worker as an employee.

Reasonable basis. In the latest Sixth circuit case, the taxpayer never treated the drivers as employees. It consistently treated them as independent contractors and issued them Forms 1099-MISC. Additionally, the taxpayer reasonably relied on state rulings that found that two of its drivers were independent contractors. The state agencies used a twenty-factor common-law test virtually identical to the test outlined by the IRS to determine if workers are employees or independent contractors.

If you need assistance in determining which of your workers are independent contractors and who will be classified as an employee for employment tax purposes, please give our office a call.

(Peno Trucking, Inc., CA-6)