IRS changes litigation position on Tax Court’s employment status jurisdiction
IRS changes litigation position on Tax Court’s employment status jurisdiction
Chief Counsel Notice 2016-002, Change in Litigation Position Regarding Section 7436 Tax Court Jurisdiction.
In a Chief Counsel Notice (CCN), IRS has advised Counsel attorneys of a change in IRS’s litigation position concerning the scope of the Tax Court’s jurisdiction under Code Sec. 7436. This change was prompted by two Tax Court decisions which concluded that, based on IRS having made a determination, regardless of whether IRS had issued a Notice of Determination of Worker Classification (NDWC), the Court had jurisdiction to determine whether the taxpayer was entitled to relief under Section 530 of the Revenue Act of ’78 with respect to remuneration paid to a taxpayer’s workers.
Background. Under Code Sec. 7436(a), if there is an “actual controversy,” a taxpayer can obtain Tax Court review of whether IRS correctly determined that: (1) an individual performing services for the taxpayer is an employee for employment tax purposes; or (2) the taxpayer is not entitled to relief under Section 530(a) of the Revenue Act of ’78 (Section 530). Under Section 530, retroactive and prospective relief from employment tax liability is provided for employers who misclassified workers as independent contractors using the common-law facts and circumstances standards. Section 530 applies only if a number of conditions are met. One of these conditions requires that the taxpayer must have had a “reasonable basis” for not treating the worker as an employee (such as judicial precedent or IRS rulings, a past IRS audit, or a long-standing practice of a significant segment of the relevant industry).
Code Sec. 7436(b)(2) provides that, if IRS sends notice to the taxpayer of an employment status determination by certified or registered mail, no proceeding may be initiated in the Tax Court with respect to the determination unless the pleading is filed before the 91st day after the date of such mailing.
Code Sec. 7436(d)(1) provides that the principles governing certain specified Code sections related to assessment and collection apply to Code Sec. 7436 employment status determinations in the same manner as if the determination of employment status issues were a notice of deficiency. Among these Code sections is Code Sec. 6213(a), which provides that a taxpayer generally has 90 days after a notice of deficiency is mailed to file a petition with the Tax Court, and that if a petition is filed, IRS may not assess tax resulting from a deficiency until that Tax Court case is final.
Notice 2002-5, 2001-1 CB 320 states that an NDWC is a prerequisite for Tax Court jurisdiction under Code Sec. 7436, similar to the jurisdictional requirement of the issuance of a notice of deficiency in an income tax case. The Office of Chief Counsel has historically argued that the Tax Court may only exercise jurisdiction over employment status controversies when IRS has sent, by certified or registered mail, an NDWC to a taxpayer. Accordingly, without an NDWC, the taxpayer could not petition the Tax Court, and if it did, the Tax Court would lack jurisdiction.
In two recent opinions, SECC Corp., (2014) 142 TC 225142 TC 225 and American Airlines, Inc. v. Commissioner, (2015) 144 TC 24144 TC 24, the Tax Court concluded that its jurisdiction under Code Sec. 7436 is broader than IRS’s historical view. Based on the Tax Court’s opinions, it has jurisdiction if there is:
- 1. an examination in connection with the audit of any person;
- 2. a determination by the Secretary that (a) one or more individuals performing services for such person are employees of such person for purposes of subtitle C, or (b) such person is not entitled to the treatment under Section 530(a) with respect to such an individual;
- 3. an “actual controversy” involving the determination as part of an examination; and
- 4. an appropriate pleading filed in the Tax Court.
Under Code Sec. 3509, with some exceptions, if an employer fails to withhold income tax and the employee’s portion of FICA taxes because the employer failed to treat the payee as an employee, for prior years the withholding rate is generally reduced to 1.5% of wages for income tax withholding, and only 20% of the regular amount to be withheld for FICA will generally have to be withheld.
New litigation position. Until further guidance is published, Counsel attorneys are instructed to:
- …no longer argue that an NDWC is a prerequisite to Tax Court jurisdiction when the four requirements discussed above are met;
- …continue to defend on the merits that Section 530 and Code Sec. 3509 do not apply if IRS has not reclassified the workers at issue from nonemployee to employee status with regard to services rendered;
- …coordinate with the Office of the Associate Chief Counsel (Tax Exempt and Government Entities) (TEGE) on Section 530 or Code Sec. 3509 on issues not covered below;
- …coordinate with the Office of the Tax Exempt and Government Entities Division Counsel (TEGEDC) any case-specific matter in litigation that referencesSECC, American Airlines, or other language implicating Code Sec. 7436 (TEGEDC will further coordinate such issues with TEGE); and
- …coordinate with TEGEDC any case-specific examination or collection issue relating to the application of Code Sec. 7436 for the possible issuance of an NDWC (TEGEDC will further coordinate such issues with TEGE).
Notwithstanding the change in litigation position on the Tax Court’s jurisdiction, the CCN notes that Counsel will continue to defend on the merits that Section 530 and Code Sec. 3509 do not apply to any tax periods in which the taxpayer treated the workers as employees for federal employment tax purposes with regard to services provided. More specifically, Counsel will not equate a finding that the requisite actual controversy exists for Code Sec. 7436 purposes with a finding that the taxpayer did not treat the workers as employees for employment tax purposes—a threshold requirement for application of Section 530 and Code Sec. 3509. Thus, where a taxpayer treated an individual as an employee for purposes of employment taxes, Counsel will defend on the merits that Section 530 does not apply, without a need to reach the elements that a taxpayer must satisfy to be entitled to relief under Section 530.
Similarly, the threshold requirement for application of Code Sec. 3509 is that an employer fails to deduct and withhold any tax under chapter 24 (income tax withholding) or subchapter A of chapter 21 (FICA tax on employees) with respect to any employee by reason of treating such employee as not being an employee for purposes of such chapter or subchapter. Thus, where a taxpayer treated an individual as an employee within the meaning of the income tax withholding or FICA tax provisions, such as by withholding FICA tax from payments made to the individual, Counsel will defend on the merits that Code Sec. 3509 does not apply to determine the taxpayer’s liability.
The requisite thresholds that the taxpayer has not treated the individual as an employee for employment tax purposes (Section 530 threshold) or that the taxpayer has treated the individual as not being an employee (Code Sec. 3509 threshold) require that the taxpayer did not treat the individual as an employee for federal tax purposes with regard to the provision of services by the individual during the period(s) at issue. In this regard, Counsel will not view treating the services as other than employment due to the application of an exception from the term “employment” in Code Sec. 3121(b) or other special rules, or treating the payments as other than wages due to the application of an exception from the term “wages” in Code Sec. 3121(a) or other provisions as treatment of the individual as not being an employee.
Furthermore, Counsel will not view a taxpayer’s nonwage treatment of payments made to an individual otherwise acknowledged to be an employee of the taxpayer for federal employment tax purposes as treatment of the individual as other than an employee unless the payments are attributable to separate, identified services provided by the individual for which the individual has not been classified as an employee.
References: For Tax Court jurisdiction to determine employment status, see FTC 2d/FIN ¶ U-2143; United States Tax Reporter ¶ 74,364; TaxDesk ¶ 806,067.