IRS Provides Guidance on Corporate Officer's Work Status Classification

Are corporate officers entitled to treatment under Section 530 of the Revenue Act of 1978 and, if so, is submission of a Form 1099 sufficient to establish the corporation's treatment of that worker as an independent contractor? Further, is the Classification Settlement Program (CSP) available when compensation to a corporate officer is mischaracterized, rather than when the officer's worker classification is incorrect?

Section 530 Relief for Corporate Officers and Submission of a Form 1099 as Sufficient Treatment for Independent Contractor Status

Under Section 530(a)(1) of the Revenue Act of 1978, termination of certain employment tax liability is appropriate if a taxpayer (1) did not treat an individual as an employee for any period, (2) consistently treated the individual as a nonemployee on all required Federal tax returns and (3) had a reasonable basis for not treating the individual as an employee. Additionally, under Section 530(a)(3), a taxpayer cannot have treated any individual in a substantially similar position as an employee for any period. However, Section 530(d) contains specific exceptions from employment tax liability relief under Section 530(a). Specifically, in the context of a three-party service arrangement in which a business provides workers to a client, Section 530 relief is unavailable if a worker provides services "as an engineer, designer, drafter, computer programmer, systems analyst, or other similarly skilled worker engaged in a similar line of work."

The language of Section 530 contains no specific exclusion that would prevent a taxpayer from obtaining relief if the Service determined that its corporate officers were employees. Indeed, when Congress was considering exceptions to Section 530 relief, its intent was to except workers under the common-law rules retained by businesses that provide technical services. Accordingly, the Tax Reform Act of 1986 amended Section 530 by adding the specific exclusions under Section 530(d). Corporate officers are not included in this exclusion. Further, Rev. Proc. 85-18 specifically stated that "[f]or purposes of Section 530(a) of the Act, the term employee means employees under Sections 3121(d), 3306(i) and 3401(c) of the Code." Corporate officers are defined as employees under Secs. 3121(d)(1), 3306(i) and 3401(c).

Although Rev. Proc. 85-18 explained that, for Section 530 relief, the term "employee" means those individuals defined as employees under Secs. 3121(d), 3306(i) and 3401(c), it has been suggested that Congress's intent was to limit this relief to common-law employees. However, the language of Section 530(a) makes no statement that indicates this treatment is applicable only to common-law employees. Indeed, although Section 530(d) specifically lists the exceptions to Section 530, no "corporate officer exception" is included. Additionally, the Employment Tax Handbook explains that, for purposes of Section 530 relief, the workers involved must be defined as employees under Sec. 3121(d). It also explains that corporate officers are employees under Sec. 3121(d) for Section 530 relief purposes. Further, Rev. Proc. 85-18 specifically indicated that corporate officers are employees for purposes of Section 530 relief.

Therefore, if a taxpayer did not treat a corporate officer as an employee and meets the other Section 530 requirements for relief from employment taxes, the taxpayer would be entitled to Section 530 relief consideration.

As to whether submission of a Form 1099 is sufficient to establish a taxpayer's treatment of corporate officers as independent contractors rather than employees, for purposes of Section 530 relief, Rev. Proc. 85-18 interpreted the word "treat" within the context of a Section 530(a)(1) relief determination. That revenue procedure included guidelines for determining whether a taxpayer did not "treat" an individual as an employee for any period for Section 530 relief purposes. These guidelines note that treatment as an employee includes such actions as withholding income tax or FICA tax from an individual's wages or filing employment tax returns for a period for the individual.

When the taxpayer treats the individual as a nonemployee by filing a Form 1099, this would support a determination of nonemployee treatment, as required under Section 530(a)(1)(A). However, this determination is highly fact-specific and Section 530 requires review of several additional related factors to determine if employment tax relief is appropriate. The taxpayer's filing of a Form 1099 for the individual must be consistent with its treatment of the individual as a nonemployee. Further, the taxpayer must also not have treated any individuals with substantially similar positions as employees for employment tax purposes for any period after 1977. Finally, the taxpayer must have had some reasonable basis for treating the individual as a nonemployee.

When asking if Section 530 applied to all corporate officers, you also asked how Rev. Rul. 82-83 affected treatment of corporate officers under Section 530. Rev. Rul. 82-83 involved a corporation that treated its officers as independent contractors, without reliance on any "safe haven" basis under Section 530(a)(2)(A), (B) or (C), and characterized their compensation as "draws" rather than as "salaries." Additionally, the officers were compensated, as independent contractors, for services that are typical and customary for officers to perform (i.e., fundamental decisions regarding corporate operations) and that are rarely delegated to independent contractors. According to the ruling, it was "a question of fact in all cases whether officers of a corporation are performing services within the scope of their duties as officers or whether they are performing services as independent contractors." Based on those facts, it was held that the corporation was not entitled to Section 530 relief; there was no reasonable basis for it to treat its officers as nonemployees, even with a liberal interpretation of the reasonable basis requirement in Section 530.

Rev. Rul. 82-83 provides useful guidance when evaluating whether a corporation had some reasonable basis for treating corporate officers as nonemployees. It also can serve as an example to illustrate that Section 530 has two separate threshold requirements that must be met prior to application: "treatment" and "reasonableness." The initial requirement is that a taxpayer must properly "treat" the individual as a nonemployee (including the reporting requirements and consistency requirements). Then, if properly "treated" as a nonemployee, that treatment must have been "reasonable." Reasonableness can be established by the use of statutory standards (reasonable reliance on one of the three standards provided in Section 530(a)(2)) or by some other means. Both requirements are highly fact-specific and Rev. Rul. 82-83 illustrated that, although the officers might have been properly "treated" as nonemployees, that treatment was not "reasonable" under the facts of that case.

Therefore, filing a Form 1099 may establish that a taxpayer did not "treat" a corporate officer as an employee (when that filing was consistent with its treatment of the officer as a nonemployee in other nonfiling contexts, and when other individuals with substantially similar positions were not treated as employees). Then, prior to application of Section 530 relief, it must be separately determined whether the taxpayer also had a "reasonable basis" for treating the officer as a nonemployee (based on the statutory standards or by some other means).

CSP Relief If Compensation to a Corporate Officer Has Been Mischaracterized

The CSP establishes standard settlement agreements in worker classification cases, and allows businesses and tax examiners to resolve worker classification cases as early as possible in the administrative process. CSP cases involve determinations by the Service that a worker is an employee and that the taxpayer is not entitled to Section 530 relief. A business that issued timely Forms 1099 for payments it made to a corporate officer and treated that officer as an independent contractor is eligible for the CSP.

However, the Employment Tax Handbook explains that the CSP is available exclusively for worker classification issues. Because the CSP is available exclusively for worker classification issues, it is appropriate for use when a business clearly meets the Section 530 relief requirements, but would rather treat workers as employees. A CSP offer for prospective treatment allows a taxpayer to begin treating workers as employees without negating their claim for Section 530 relief for prior years.

Specifically excluded for CSP consideration are cases that involve reclassifying distributions to officers/shareholders as wages. Therefore, for example, if a taxpayer already treated an officer/shareholder as an employee and the Service determined that some profit distributions should be characterized as wages, the case would not be eligible for the CSP. Additionally, the CSP is not available for issues other than worker classification, which "includes cases in which a threshold issue, such as the nature of a payment as dividends or wages, has not been resolved at the examination level." The CSP is available exclusively for worker classification issues. Accordingly, the CSP is not available to resolve issues involving the nature of compensation paid to corporate officers.

IRS Letter Ruling (CCA) 200038045 (8/9/00)